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What to do with a non-deductible Traditional IRA?

I mistakenly opened an non-deductible Trad. IRA in 2014 thinking the contribution could be tax deductible, but turns out it couldn't because I participate in a qualified 401k plan with my company.

I wasn't very savvy back then and I contributed AGAIN in 2015, so now I have $11,000 in the account. I haven't made any earnings on it as it has been sitting in a money market account.

What are my options: Should I keep it in the Trad IRA and consider investing it more aggressively than the money market? Can I withdraw it without any penalty since i haven't made any earnings on it? or Is it better to roll it over into a Roth IRA that I will be opening this year? Thanks!

Feb 04, 2016 by Lola in  |  Flag
7 Answers  |  8 Followers
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2 votes
Peter C. Karp Level 20

Hi Lola,

You could keep the funds in your Traditional IRA and invest it more aggressively but the downside is that all of the gains you accrue in your IRA will be taxable at the time of withdrawal. If you were to withdraw the funds from your Traditional IRA now, you wouldn’t pay income tax but you’d be subject to IRS penalties. As your IRA balance is exclusively after-tax dollars, you can convert to a Roth IRA to allow those funds to grow tax-free. Anyone is eligible to convert regardless of their income or tax filing status.

Regards, Peter

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Comment   |  Flag   |  Feb 12, 2016 from San Francisco, CA

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1 vote

Convert it to a Roth IRA. The earnings would be the only taxable amount at conversion, and you don't really have any since its been in a Mmkt. You may be able to make annual contributions to a Roth, deopending on your income.

1 Comment   |  Flag   |  Feb 05, 2016 from Canton, GA
Lola

Thank you! I qualify for a Roth, so definitely rolling that over asap

Flag |  Feb 05, 2016

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1 vote

Lola,

No problem with what you have done to date. Now follow the following steps to maximize your benefits:

  1. Convert or transfer all the Non-deductible IRA funds to a Roth IRA and let them grow tax free forever!
  2. Did you file tax form 8606 and disclose your $5,500 non-deductible contribution when you filed your
    2014 Federal taxes? If not amend and file.
  3. File form 8606 again in 2015 and disclose your $5,500 contribution.
  4. Your conversion will be reported with your 2016 tax return on form 8606

Regarding investing theses funds you have many option better then a money market which will not outpace inflation. Remember this investment should be based on your personal risk tolerance and time frame. Please keep in mind that a Roth grows TAX FREE, so you should be more aggressive with these funds assuming you don't need them in the short term and you want them to grow and meet your long-term needs.

Take care.

Robert Riedl CPA, CFP, AWMA Endowment Wealth Management www.EndowmentWM.com

2 Comments   |  Flag   |  Feb 05, 2016 from Milwaukee, WI
Lola

Thanks Robert! Tax form 8606 would have been part of my Turbotax filing documents right? Or would that have been a separate form I had to file?

Flag |  Feb 05, 2016
Robert L. Riedl, CPA, CFP®, AWMA®

Lola,

Flag |  Feb 06, 2016 near Milwaukee, WI

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1 vote
Larry R Frank Sr Level 20

Very good questions Lola. You didn't state your age or income which are a couple of factors to consider for a complete answer. In general, you would want to max out your 401k contributions each year simply to be saving for your retirement. You didn't mention if you filed the IRS Form 8606 ( https://www.irs.gov/uac/About-Form-8606 ) which is what tells the IRS not to tax you on that money when you withdraw it in the future. If you haven't file the 8606 for both years, you still have time to do so (and you need to do that first before conversion so the IRS paperwork is correctly dated. It also sounds like you did not have an IRA already (if you did there are complications https://www.irs.gov/publications/p590b/ch01.html#en_US_2015_publink1000230812 ). Assuming you don't have other IRAs, and you have a number of years before you retire and would use the money, converting to a Roth sounds like your best choice. This doesn't solve the investing part of your question since the title IRA or Roth is just that, a title - how either is invested depends on what you choose for that. I suggest you visit Vanguard's website which has helpful tools and an easy process to do that all for you - both the process of conversion and how to invest it that depends on how comfortable you are with risk.

View all 5 Comments   |  Flag   |  Feb 05, 2016 from Roseville, CA
Lola

One more thing, should I wait till all this is resolved before opening my ROTH IRA account (so I can sock away my $5500 for this tax season), or can I go ahead and open it now without it complicating the process?

Flag |  Feb 05, 2016
Larry R Frank Sr

You can open a Roth now at Vanguard and then follow Vanguard's conversion process for the next step. If you made a contribution for 2015 already, then you can't do another into a Roth (or IRA) for 2015 again, because the maximum of $5500 applies to both combined. So your next contribution is for 2016 (if I follow your timing) which you can do anytime this year. So 2016 contribution can be in a new Roth anytime in 2016 (you'd claim that contribution in 2017 when you do 2016 taxes) which isn't related to what you've done in the past and not related to tax forms for 2014 or 2015. The conversion needs to wait until you got your taxes done for this year just to have the dates in the proper order on all the forms.

Flag |  Feb 05, 2016 near Roseville, CA

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I agree with above messages. That kind of amount should be converted into a ROTH IRA if is not going to be a tax burden for you. (consult with a CPA before you decide such) Just be aware that tax is deemed for the entire amount if you have taken a deduction, if not only on the profit. I hope this helps!

Comment   |  Flag   |  Feb 08, 2016

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Tunc Tanin Level 10

Some of the advice given here is misleading. It would only make sense for you to convert to a ROTH IRA f you have no other IRA accounts. You can't just convert your non deductible IRA and ignore the other IRA's

Comment   |  Flag   |  Feb 08, 2016 from Somerville, MA

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Tunc Tanin Level 10

Some of the advice given here is misleading. It would only make sense for you to convert to a ROTH IRA f you have no other IRA accounts. You can't just convert your non deductible IRA and ignore the other IRA's

Comment   |  Flag   |  Feb 08, 2016 from Somerville, MA

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