wow, there is a lot I didn't know about Roths

**disneysteve** · 12-21-2010, 04:21 PM

Okay. I read through this a couple of times and I think I've got it straight.

Why not just open a non-deductible traditional IRA. Fund that and then convert it to a Roth?

You would still be left with the deductible IRA account, but you have to pay tax on that money eventually anyway. Even with the solo 401k, that money will be taxed upon withdrawal.

**KTP** · 12-21-2010, 05:50 PM

Originally posted by disneysteve View Post

Okay. I read through this a couple of times and I think I've got it straight.

Why not just open a non-deductible traditional IRA. Fund that and then convert it to a Roth?

You would still be left with the deductible IRA account, but you have to pay tax on that money eventually anyway. Even with the solo 401k, that money will be taxed upon withdrawal.

Sigh...you spend too much time decluttering and not enough time reading the back and forth discussions on Roth conversions between me and Jim

When you convert a non-deductible traditional IRA the IRS requires you to lump all of your different IRA accounts together and examine the cost basis to caculate the tax due. So in my case, if I funded a $5000 non-deductable IRA and attempted to convert it to a Roth, I would owe tax on $51,000/$56,000 or 91% of the $5000. For my ~33% tax bracket, this would be about $1500.

If I hide the $51,000 by rolling it into a solo 401K, then I would owe zero tax on the $5000. Since I keep growing my regular IRA nicely each year, I would probably continue to owe $1500 every year I want a $5000 Roth unless I take this one time step to hide the deductable IRA in the solo 401K. Is it worth all the trouble? Not sure. Could be about $10,000 in defered tax...

**jIM_Ohio** · 12-21-2010, 05:56 PM

a 1099 R will be issued when 401k is liquidated or converted, you will pay taxes on conversion

**KTP** · 12-21-2010, 06:02 PM

Originally posted by jIM_Ohio View Post

a 1099 R will be issued when 401k is liquidated or converted, you will pay taxes on conversion

Can you explain this a bit more Jim (I didn't know you could still post, btw. Thanks!)

Do you mean the 401K would get taxed when you withdrew the funds, or do you mean if a number of years down the road I rolled the 401K back into a traditional IRA that taxes would become due? Or do you mean it would get taxed double?

Would there still be an advantage to this if I did the liquidation or conversion down the road in a tax year where I had zero income? (for example if we lived off our taxable account savings for a year)

**jpg7n16** · 12-21-2010, 06:20 PM

As long as the funds are still in the pre-tax vehicle, they have no basis. If they are moved out of the pre-tax vehicle (in this case, a 401k) there is a taxable event.

They use your basis in order to determine what will not be taxed, and then tax on the value.

So the reason you're getting 51k/56k is because 5k of that has a cost basis - because you contributed to a non-deductible IRA (post tax money). The remaining $51k was pre-tax money and would be taxed at your highest marginal rate. (for you 33%)

So the correct calculation would be: Value of Distribution - Cost basis = Taxable Income

Or $56,000 - 5,000 = $51,000 taxable income

So like DS said, you could just fund the non-deductible and convert it to a Roth, and achieve the same goal, without incurring taxes on $51k.

Since your non-deductible IRA has a basis of $5k and a value of $5k, there is no taxable gain, so no tax due on conversion. (edit: see below as this isn't accurate if holding money across multiple IRAs)

**KTP** · 12-21-2010, 06:34 PM

Originally posted by jpg7n16 View Post

So like DS said, you could just fund the non-deductible and convert it to a Roth, and achieve the same goal, without incurring taxes on $51k.

Since your non-deductible IRA has a basis of $5k and a value of $5k, there is no taxable gain, so no tax due on conversion.

Sorry, that is not how it works.

**jpg7n16** · 12-21-2010, 06:50 PM

The main idea to remember is that you will only be taxed on a dollar of income once. (0 times if qualified withdrawal of earnings from a Roth IRA)

If you fund a Roth, you have been taxed on that money already, so it is not taxable again if you withdraw your contribution. Roth IRA's have a cost basis. Essentially the cost basis establishes how much of the account has already been taxed. You were already taxed on the $5k used for your contribution. But the Roth is a special animal in that it gets tax-free withdrawals. So even though never paid tax on income from investment earnings, you never will.

If you contribute to a non-deductible IRA, the contribution has already been taxed, so you will not pay taxes on it again. This is why the non-deductible IRA has a cost basis. But any earnings in the non-deductible IRA have not been taxed yet. You would incur taxes if you chose to withdraw/convert any earnings. Use the same Value of Distribution - Basis = Taxable Income.

If you contribute to a deductible IRA (or a 401k), you are essentially getting a 'deduction' for switching some post-tax money, back to pre-tax. Therefore you deduct that contribution from your current year's income. (saving you taxes on that amount) But since it is now 'pre-tax' (due to your tax deduction), it has not been taxed once yet. Whenever it's withdrawn, it will be taxed once. As the contribution has technically not been taxed, and all earnings have not been taxed, it's all taxable when withdrawn.

(edit: see below as this isn't accurate if holding across multiple types of IRAs)

**jpg7n16** · 12-21-2010, 06:53 PM

Originally posted by KTP View Post

Sorry, that is not how it works.

I'm pretty sure it is, but I'm still looking into it. And I found a site that claims that the IRS will consider all your accounts as one big account when trying to determine the basis - which I was not aware of.

(link: 2010 Traditional IRA to Roth IRA Conversion Tax Rules)

So if you have that $51k in a deductible, then apparently they will treat all the accounts as being combined into one super IRA. Which I didn't know. (Apparantly monies held in 401k's do not enter the equation, so maybe that's what you were trying to do in post #1? If the IRA money was instead held in a 401k, it looks like my statement would be true. But as is I was wrong on that)

The principle remains the same, but looks like I was wrong on the specifics on that. Sorry.

Avoiding Too Much Tax On Your Distributions

How to Handle Distributions
If it turns out that there are non-deductible contributions in any of your Traditional IRAs, you have a cost basis in those funds. This is a good thing because it means that because they are a return on your investment, they are not taxed when they are distributed to you. Don't get too excited just yet, though. You can’t just assume that the initial withdrawals are tax-free up to the amount of the basis, even if you only made a few non-deductible contributions over the years. In other words, only the part of the distribution that represents non-deductible contributions (your cost basis) is tax-free. (To learn more, read How do I figure out the cost basis on a stock investment?)

The distributions will consist of non-deductible contributions (the cost basis) and deductible contributions, earnings, and gains (if there are any). Therefore, each distribution is partly nontaxable and partly taxable. To calculate this, add the total of your non-deductible IRA contributions and any after-tax money rolled in from retirement plans, then divide that sum by the total amount of money in all of your IRAs at the end of the year. The result is the percentage of the distribution that's tax-free. You'll continue to go through the same exercise each year until your cost basis has been removed.

**KTP** · 12-21-2010, 09:02 PM

Originally posted by jpg7n16 View Post

So if you have that $51k in a deductible, then apparently they will treat all the accounts as being combined into one super IRA. Which I didn't know. (Apparantly monies held in 401k's do not enter the equation, so maybe that's what you were trying to do in post #1? If the IRA money was instead held in a 401k, it looks like my statement would be true. But as is I was wrong on that)

The principle remains the same, but looks like I was wrong on the specifics on that. Sorry.

Right. Sorry if I was a bit terse in my response...I was in a hurry at the time. I have spent a lot of time researching the exact stuff you discovered (the fact that the IRS lumps all of your different IRA accounts into one super account for tax determination purposes on conversions).

Anyway, it is starting to look like this hide-the-IRA-in-solo-401K strategy would actually work. I am not sure what Jim meant with the 1099R or if he was just meaning that eventually you would have to pay taxes on the IRA money you rolled into the 401K. That would be fine, as you would have had to pay taxes on it coming out of the IRA as well if it was all deductable contributions + earnings.

Here is how I think it would work.

Get some earnings (I can generate some small earnings soon with my company via ebay sales).

Open a Fidelity solo 401K with earnings (say $500?)

Roll the $51,000 IRA into the solo 401K, giving it a $51,500 balance

Contribute $5000 to a new non-deductable IRA

Roll this IRA immediately into a Roth, paying $0 in tax

Repeat previous two steps for as many years as you can

Retire with fat Roth and a taxable 401K, but your tax bracket has *probably* shrunk from 33% to 15% or less

**Like2Plan** · 12-22-2010, 04:46 AM

KTP,
So, you would leave the 51K intact in the 401k and the Roth convervsion would only apply to new non-deductable ira $$?
It seems that there are little nuances to the 401K rules--my DH is not permitted to roll over his traditional IRA in his 401K, but I can.
I didn't know you could set up a 401K for one individual, though. (I thought it was called something else with slightly different rules if you are self employed. )
If you were able to set up a 401k for yourself (assume you set the rules to permit rollovers

), then I believe under current tax law you could do what you are proposing.

**Like2Plan** · 12-22-2010, 05:01 AM

Ah, here we go. Obviously, I don't know a lot about them, but here are a couple of links:

Keogh Account Definition

Keogh Account

**Petunia 100** · 12-22-2010, 03:01 PM

KTP, your plan is a very smart one. Good job!

wow, there is a lot I didn't know about Roths