Many resolute retirement savers sock money away in traditional IRAs even if they don’t get a tax deduction on contributions. That can have an unplanned and pleasing result: minimizing taxes if you convert to a Roth.
But non-deductible contributions can also make the tax calculations trickier, and they can complicate decisions about how to handle other types of retirement accounts such as 401(k)s.
When a traditional IRA is converted into a Roth, the account owner must pay taxes on all money that has not been taxed before, including investment gains and tax-deductible contributions. But no tax is due on non-deductible contributions, since they came from money that had already been taxed.
Suppose, for example, that you had a traditional IRA worth $100,000, including $20,000 in deductible contributions, $30,000 in non-deductible contributions and $50,000 in investment gains.
If you converted the whole account, you’d owe federal income tax on the $70,000 in deductible contributions and investment gains. (Use the Roth IRA Conversion Calculator to see if conversion makes sense.)
That’s simple enough. It gets more complicated if you have multiple IRAs. You might not want to convert all of them to Roths because the tax bill would be too big. In that case, you could convert just some of the accounts or just a portion of one or more accounts, in any combination you like.
But the tax bill would be based on the taxable portion of all the accounts taken together. Imagine that in addition to the account discussed above you had a second traditional IRA worth $50,000, all of it from deductible contributions and investment gains. You also have a $40,000 IRA with $10,000 in non-deductible contributions and $30,000 in gains.