How Can You do a Roth Conversion, Tax Free?

So you’re hearing all about this Roth IRA conversion – for 2010 there are no income limitations as there have been in the past – and you’re wondering if there is a way to do this tax free… There are actually several, three of which I’ll list here.

After-Tax IRA Contributions

If your IRA is composed only of after-tax (non-deducted) contributions, you can convert those funds over to a Roth IRA without tax consequence.  This is because the funds were taxed before you contributed them to the IRA, and so no tax is due when you convert the funds to a Roth IRA.

The “gotcha” in this is that the IRA must be ONLY non-deducted, after-tax contributions.  Plus this must be the only IRA that you have – see the this post for the “Turns Out You CAN Be A Little Bit Pregnant” rule.  There’s also a way around the “Pregnant” Rule in that post.

After-Tax Qualified Retirement Plan Contributions

If you happen to have after-tax contributions to a Qualified Retirement Plan (QRP), these can be rolled over tax free if you’ve terminated employment – without having to worry about the “Pregnant” rule I mentioned above.  This is because QRP funds are treated differently, and as such you are allowed to move specific contribution money separate from other contribution money (e.g., pre-tax contributions separate from after-tax contributions).

Zero Tax Bracket

If you have no or very low taxable income, that is, if you’re below the 10% tax bracket, any funds that you distribute from your IRA up to the limit – which would be your AGI minus your exemptions and itemized or standard deductions and any tax credits – would be tax free.  Granted, this is likely to be a somewhat small amount for most people in this situation, but for others, such as business owners or farmers with carried-over Net Operating Losses, it could be sizeable.  See this post for more information on NOL carryovers and Roth IRA conversions.

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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