Dear Dr. Don,
I am 33 years old and have been contributing to a nondeductible IRA for nine years that is now worth about $40,000. I want to convert to a Roth IRA. As long as I have reported my nondeductible contributions on Form 8086 each year, am I exempt from paying tax on the conversion amount? If not, am I wise to convert given my age and the value of the account?
-- Mark Mechanistic
It's actually Internal Revenue Service Form 8606, Nondeductible IRAs, that you use to report these nondeductible contributions to a traditional IRA. You made contributions with after-tax dollars, so the contributions aren't subject to a second round of income taxes as you convert your traditional IRA to a Roth IRA. The investment gains (fund growth) in excess of your nondeductible contributions, however, are taxable in the conversion from a traditional to a Roth IRA.
If you forgot to file a Form 8606 on the nondeductible contribution in one or more years, contact the IRS about filing the form. I've gleaned from Bankrate tax expert Kay Bell that you can file the form late and typically, the IRS won't require you to pay a late fee if you can show reasonable cause for not filing the 8606 on time. However, you may be subject to a $50 late filing fee. You don't need to file an amended return, just the 8606 form. The IRS has a Web page that contains links to old IRS forms, where you can find the prior year 8606 forms.
I think it's a slam dunk for you to convert for a lot of reasons. One, you've already paid most, if not all, of the taxes due on conversion and you can grow this portfolio tax-free from now until retirement. Two, I'm a bit of a pessimist and expect tax rates to be going up in the future.
Still, as a belt-and-suspenders kind of adviser, I'd suggest that you input your information and expectations into a calculator like Bankrate's Convert IRA to Roth calculator to see the expected advantages associated with the conversion.
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