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The IRA Two Step

There’s a recurring question regarding whether one should rollover a 401(k) from a previous employer to an IRA account (or to the new employer’s 401(k)) or leave it in the original account. One new variable that comes into play is the ability to convert one’s IRA to a Roth IRA, regardless of income, in 2010. How are the two related? When one converts from a regular IRA to a Roth, taxes (at your marginal rate) are due on a prorated basis on the pretax money within the IRA. For example, if you have a $100,000 balance, $20,000 of which is post tax deposits, 80% of any money converted is subject to tax. Now, this presents an interesting opportunity. Most 401(k) accounts will permit IRA money to be rolled back into the 401(k) regardless of the source. So in this example, you might consider rolling the $80,000 in pre tax money into the 401(k) before doing the conversion on the $20,000 post tax money. This two step will avoid any and all tax on that conversion. If you have a 401(k) account, you might consider leaving it for now, and converting it to an IRA only after that Roth conversion is made in 2010.

Joe

{ 2 comments… add one }
  • steve long July 25, 2012, 5:29 pm

    I am receiving a K1 capital gain of $120,000. I would like to shelter all that I can from tax burden.
    Presently I an liable for a 15% knock. If I place portions in step IRA’s for my self and wife how much can I place there?

  • JOE August 23, 2012, 10:25 pm

    Steve, these are separate issues. The gain can only be negated by capital losses. Put $10,000 into a deductible IRA and you’ll save some money at your marginal rate, but that’s no different for any year.

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