Real Estate IRA Caveats

Investing in real estate inside an IRA comes with strict rules. Complication number one: Owning property in an IRA negates all the familiar tax benefits of owning investment real estate, says James Lange, a CPA and financial planner in Pittsburgh. You can’t deduct property taxes or mortgage interest or take advantage of depreciation.

Aggravation number two: There’s a long list of prohibited transactions. You and your relatives are barred from occupying or working on the property, so forget free rent or “sweat equity.” The IRA, not you, owns the place, so if you’re considering a rental property, you’ll need a property manager to find tenants. Every dollar you invest in the property, plus expenses such as roof and furnace repairs, must come out of the IRA. Flout any rule and it’s a Catastrophe: The tax-deferred status of your entire IRA is ruined, and you’ll owe income taxes on the full value of the IRA’s assets, plus a 10% penalty if you’re younger than 59½.

Contact Connie Dello Buono, helping doctors and business owners reduce income taxes via a busiess structure and financial strategy. 408-854-1883 or Schedule a phone chat with our sr investment advisor

Net Unrealized Appreciation and Qualified Retirement Plan Distributions

Often, individuals employed by large corporations have the option to invest some of their qualified retirement plan contributions (e.g., 401(k) contributions), as well as employer contributions, into their employer’s stock. If you believe in the long term prospects of the company, that may make sense as part of your asset allocation strategy.

But what happens to that stock when you retire or leave the company? What happens if you still believe in the future prospects of the company and still considers the company stock a sound investment? You probably already know that distributions from a qualified plan can be somewhat complicated and have income tax consequences. But, is there a distribution strategy that may be effective to help you maintain the stock and minimize income taxes when you leave the company?

A Possible Solution: Net Unrealized Appreciation (“NUA”)

NUA is a tax strategy that allows you the opportunity to convert taxable ordinary income into long-term capital gain. Ordinarily, if you took a lump sum distribution of the assets in the plan, you would pay ordinary income taxes. However, when company securities are part of the distribution from the plan, using the NUA strategy, you can pay ordinary income taxes on just the cost basis of the shares, but defer and convert to capital gain the tax on the difference between the fair market value of the shares and the average cost basis of those shares. The difference is the net unrealized appreciation. When the shares are actually sold, the NUA will be taxed at long term capital gains rates regardless of how long the plan held the shares. If there is additional appreciation of the shares after the shares are distributed from the plan, that growth is taxed as long or short-term capital gains, depending on whether the ultimate sale is more or less than one year after the distribution.

Note: you can elect to pay the taxes upon distribution instead of waiting until the shares are sold. In some situations, depending upon cash flow concerns and anticipated future tax rates, payment of the taxes at distribution may make sense. In addition, in order to qualify as a lump sum distribution, the distribution must be on account of death, separation from service or the attainment of age 59 ½ years. (The definition is slightly different for self-employed persons: “separation from service” does not qualify; disability does.)


Jim, age 60, is ready to retire and has a balance in his employer’s retirement plan of $300,000, including company stock with an average cost basis of $30,000, and a fair market value of $130,000 (the NUA is thus $100,000). Jim’s account is a result of the many years of pre-tax contributions and employer matches to the account. If Jim takes a lump sum distribution from the plan, normally, he would pay ordinary income tax on the full $300,000 in the year of distribution. Under the NUA strategy however, Jim deposits the company stock into a brokerage account but does not sell it. As a result, only the $30,000 average cost basis of the company stock, and the $170,000 value of the other assets in his account (for example, mutual funds), would be taxed at ordinary income rates. The NUA would not be taxed. Sometime later, Jim sells the company stock. At that time, the NUA will be taxed at long term capital gains rates when the employer securities are sold, regardless of the holding period. However, any additional appreciation of the securities after distribution from the plan is taxed as either a short or long term capital gain depending on Jim’s holding period after distribution.

Now, suppose that instead of taking a lump sum distribution, Jim wants to roll over his entire qualified plan account into an IRA. This may be the appropriate strategy depending upon Jim’s situation. However, by rolling over the company stock into the IRA, the NUA tax treatment would be lost. Jim should take the company stock, place it into a regular brokerage account and roll over the remaining balance to an IRA. Jim would roll over the $170,000 of his account balance (i.e., everything other than the company stock) to an IRA. He would take a direct lump sum distribution of the $130,000 in company stock and place it in a securities brokerage account. $30,000 would be ordinary income, and the $100,000 of NUA would qualify for the special tax treatment.

If Jim was under age 55 at distribution, (or even if he were under 59 ½ and not leaving the company, he would not be able to take a lump sum distribution from the plan without a 10% premature distribution penalty on the taxable portion, i.e. the $30,000 average cost basis component of the stock distribution. In that case, Jim may wish to roll the entire account into an IRA.

So far, we’ve talked about the NUA strategy using your pre-tax employee contributions and the company match, if any. Some plans also allow employees to make after-tax contributions to the plan. Suppose you also made after-tax contributions and used that money to purchase company stock?

You can roll the entire account into an IRA, but the appreciation of these shares of company stock, purchased with after-tax contributions, will be subject to ordinary income taxes when you take distributions from the IRA. Similar to the situation mentioned above, where company stock is purchased with pre-tax contributions, shares purchased with after-tax contributions should be distributed to utilize the NUA strategy. The difference is that the average cost basis is not taxed when the contributions are made with after-tax dollars. The reason: these shares were purchased with after-tax dollars so it was already taxed. The NUA and additional appreciation will be subject to capital gains tax as explained before.

Could you do a direct Roth IRA conversion of the entire plan balance and still maintain the favorable NUA tax treatment? This area is unclear, but probably not. The lack of clarity is a result of inconsistent language between certain provisions in the Internal Revenue Code, legislative history and the interpretation of these provisions by the IRS.


If you invested in your company’s stock in your employer sponsored qualified retirement plan, before you decide upon a lump sum distribution from the plan, or a rollover of the account balance, including the company stock, into an IRA, consider whether you may be entitled to use the NUA tax strategy to reduce your income tax liability.

The foregoing information regarding estate, charitable, retirement and/or business planning techniques is not intended to be tax, legal or investment advice and is provided for general educational purposes only.  You should consult with your tax and legal advisor regarding your individual situation.


Free 30min phone chat with a sr financial advisor at Harding Financial to help you reduce income taxes using a business structure and financial strategies, or 408-854-1883

Make 2014 and 2015 be the year to protect your wealth and secure your retirement.

 Connie Dello Buono
Jr Financial Advisor

401(k) Plans Are Not Just For Big Businesses

A significant portion of the small business market consists of one person businesses. If you have a client whose business is a one person operation, s/he may be a perfect candidate for a Solo 401(k) Plan. A Solo 401(k) plan is a 401(k) plan for a one-person business and may offer your client an opportunity to increase his or her tax-deductible contributions to his/her retirement plan. Additionally, if you have a client who is thinking of establishing a SIMPLE or SEP Plan, a Solo 401(k) may be a better choice that will help enable your client to maximize his or her tax-deductible contributions, and to help meet his/her long range retirement goals.

First, it’s important to understand that Profit Sharing Plans and SEP Plans allow for flexible employer contributions up to 25% of participating payroll. SIMPLE Plans only allow for employee deferral contributions which are limited to $12,000 plus a $2,500 catch-up contribution for participants age 50 or older, as indexed for 2014, but do not allow for flexible employer contributions. Since all 401(k) plans are profit sharing plans with a cash or deferred arrangement (CODA), which allow employees to contribute or defer a portion of their salary into the plan, in addition to the employer profit sharing contribution, a business owner may make both an employer and an employee deferral contribution all in one plan for himself or herself.

This means a business owner with no employees and earning $100,000, could set up a Profit Sharing Plan or SEP Plan, and make a maximum tax-deductible contribution of $25,000. However, since a plain Profit Sharing Plan or a SEP Plan only allows for employer contributions, the business owner may be limiting the amount of money that can be put aside for retirement, as well as the tax savings, with just a plain profit sharing plan or SEP Plan. By adding a 401(k) deferral element to a Profit Sharing Plan, the business owner has just increased the amount that can be contributed on a tax-deductible basis on his or her own behalf.

Let’s look at an example: There is a limit on the overall contribution that can be allocated to any individual in a profit sharing plan or SEP Plan. For 2014, the limit is 100% of compensation up to a maximum of $52,000, as indexed for 2014. The maximum individual deferral amount, as indexed for 2014, is $17,500. In addition, a participant who is age 50 or older, is eligible to make a catch-up contribution of $5,500, as indexed for 2014, for a total salary deferral contribution of $23,000. SEPs do not allow for deferrals nor a catch-up contribution, although a Profit Sharing/401(k) Plan does. So the same business owner described above could establish a solo Profit Sharing/401(k) Plan and increase his contribution amount to $48,000 which is an increase of his or her deductible contribution by 90%. The chart below illustrates a comparison of the maximum contributions applicable to each plan for a 50 year-old business owner at different salary levels.

Business Owner’s Salary

( age 50 or older)


Plan Max. Deferral

(Including Catch-up Contrib..)



Maximum Contrib. of 25%

Profit Sharing/401(k)


Deferrals and















Here’s more good news: An existing profit sharing plan may be easily amended to become a Profit Sharing/401(k) plan. In addition, contributions previously made to a SIMPLE or SEP Plan, may be rolled over, in most cases, to a Profit Sharing/401(k) plan. Furthermore, there are no reporting requirements associated with a one-participant plan or a one participant and spouse plan, until the plan assets total $250,000 or more. Even then, only a Form 5500EZ is required to be filed.

Another important benefit to establishing a Profit Sharing/401(k) Plan is that the business owner may purchase life insurance on a tax-deductible basis by purchasing it through the Profit Sharing/401(k) Plan Trust as long as the premiums are within the incidental benefit limits. This is not allowed in a SIMPLE or SEP Plan as the funding vehicle is an IRA. Profit Sharing/401(k) plans also have special rules associated with life insurance limits not available in any other type of qualified plan, such as using rollover or seasoned money to buy life insurance.

The foregoing information regarding estate, charitable and/or business planning techniques is not intended to be tax, legal or investment advice and is provided for general educational purposes only.  You should consult with your tax and legal advisor regarding your individual situation.

Contact Connie Dello Buono 408-854-1883 to have a free 30-min chat with a financial advisor.

Info expires Dec 2014

Type of Qualified Retirement Plan for high net income pros and business owners






Plan Type



Older Than Employees

Maximize Contributions, Deductions & Benefits


Fully Insured Defined Benefit Plan,

also known as a

412(e)(3) Plan

Steady Profits: Business generates enough income to support ongoing plan contributions,. Plan funding required each year.

Highest Possible Contribution, Deduction & Benefits. All Plan Assets Held in Guaranteed Annuity/Insurance Contracts. Recession Proof.


Traditional Defined Benefit Plan

Relatively Steady Profits: Business generates enough income to support ongoing plan contributions. Plan funding required each year.

Higher Contribution and Deduction than DC Plans, Lower Deduction than Fully Insured Plan, Investment Fund for Potential Asset Growth.

Older Than Employees&

Salary Over $208,000

Flexible Contributions


Traditional Profit Sharing Plan

Maximum Total Plan Contribution is 25% of Participating Payroll.

Flexible Contributions, Lower Contribution than a Defined Benefit Plan, Maximum Individual Allocation is $52,000*.


New Comparability Profit Sharing Plan

Maximum Total Plan Contribution is 25% of Participating Payroll.

Flexible Contributions, Lower Contribution than a Defined Benefit Plan, Age-weighted Allocations, Maximum Individual Allocation is $52,000*.

Older Than Employees &

Salary Under $208,000

Flexible Contributions


Traditional Profit Sharing/401(k) Plan

Maximum Total Plan Contribution is 25% of Participating Payroll Plus Deferrals.

Flexible Contributions, Lower contribution than a Defined Benefit Plan, Maximum Individual Allocation is $57,500*


New Comparability Profit Sharing/ Safe Harbor 401(k) Plan

Maximum Total Plan Contribution of 25% of Participating Payroll Plus Deferrals

Flexible Contributions, Lower contribution than a Defined Benefit Plan, Maximum Individual Allocation is $57,500*,

Age-Weighted Allocations

Younger &

Salary Under $208,000

Maximize Deductions & Benefits


Traditional Profit Sharing / 401(k) Plan

Maximum Total Plan Contribution is 25% of Participating Payroll Plus Deferrals

Flexible Contributions, Maximum Individual Allocation is $57,500*


Integrated Profit Sharing/ Safe Harbor 401(k) Plan

Flexible Contributions, Maximum Individual Allocation for is $57,500*, Allocations weighted by salary

Younger &

Salary Over $208,000

Maximize Deductions & Benefits


Traditional Profit Sharing Plan

Maximum Total Plan Contribution is 25% of Participating Payroll

Flexible Contributions, Maximum Individual Allocation is $52,000*


Integrated Profit Sharing/Safe Harbor 401(k) Plan

Owner’s Salary Higher than Employees’ Salaries, Maximum Total Plan Contribution is 25% of Participating Payroll Plus Deferrals

Flexible Contributions, Maximum Individual Allocation is $57,500*, Allocations are weighted by salary

Any Age

Minimize Cost for Other Employees


Profit Sharing/Safe Harbor 401(k) Plan with Matching Contributions Only

For businesses with employees who do not defer at all or defer very little, No required contributions except for Safe Harbor Matching Contributions which are 100% vested.

No contributions required on behalf of employees who do not defer, Maximum Possible Individual Allocation in 2014 is $33,400**


Free 30min phone chat with a sr financial advisor at Harding Financial to help you reduce income taxes using a business structure and financial strategies, or 408-854-1883

Make 2014 and 2015 be the year to protect your wealth and secure your retirement.

Connie Dello Buono
Jr Financial Advisor
Happy Holidays! Take care of your income taxes before the year ends.

Early or Premature Withdrawals from IRAs

Taking money out early from your IRA may trigger an additional tax. Generally, amounts received from a traditional, SEP, or SIMPLE IRA are taxable distributions and must be reported as ordinary income for the taxable year in which they are received. If you are under age 59 1/2, any distributions received are considered early or premature distributions and are subject to an additional penalty tax equal to 10% of the taxable amount of the distribution. (It should be noted that that this penalty tax may be increased to 25% in the case of distributions from SIMPLE IRAs during the first two years of participation in the SIMPLE IRA.) However, the penalty tax does not apply in certain situations. Below is a list of exceptions to the additional penalty tax on early or premature IRA distributions pursuant to IRC Section 72(t).

The exceptions are as follows:

  1. Distributions made to the beneficiary or the individual’s estate in the event of the death of that individual.
  2. Distributions attributable to the individual’s disability.
  3. Distributions made for medical care to the extent allowable as a medical expense deduction for amounts paid during the taxable year which is in excess of 10% of the individual taxpayer’s Adjusted Gross Income (AGI).
  4. Distributions made to unemployed individuals for payment of health insurance premiums provided the individual has received unemployment compensation for at least 12 weeks and the withdrawal is made either in the same year the unemployment compensation was received or in the year immediately following the receipt of unemployment compensation. This exception may also apply to self-employed individuals who would otherwise not be eligible for unemployment compensation because they are self-employed.
  5. Distributions made to pay “Qualified Higher Education Expenses” during the taxable year for the taxpayer, the taxpayer’s spouse, child or grandchild of the taxpayer or the taxpayer’s spouse provided the distribution occurs within the year the expenses were incurred. A “Qualified Higher Education Expense” includes tuition, fees, books and equipment required for enrollment at any “eligible educational institution” which is defined as any college, university, vocational school or other post-secondary educational institution described in the Section 481 of the Higher Education Act of 1965. This also includes special needs services incurred in connection with such enrollment or attendance. Room and board, up to a certain amount, is also included provided the student is enrolled at least half-time. It’s important to note that these expenses are reduced by any scholarships or educational assistance received by the individual.
  6. Distributions that are ‘qualified first-time homebuyer distributions.
  7. Distributions that are part of a series of substantially equal periodic payments made (at least annually) for the life or life expectancy of the individual or the joint lives or joint life expectancy of the individual and his or her designated beneficiary.
  8. Distributions that are qualified hurricane distributions” which may not exceed $100,000.
  9. Distributions that are “qualified reservist distributions” which are distributions made to reserve members of the U.S. military called to active duty for 180 days or more at any time after September 11, 2001. But reservists have the right to return the amount of any distributions for two years following the end of active duty.

It’s important to note that these exceptions only apply to taxable IRA distributions and are different than the exceptions applicable to qualified plans. As always, you should consult your tax or legal advisor as to the best course of action based on your unique circumstances when considering taking an early distribution from an IRA. For more information please refer to IRC Section 72(t) and IRS Publication 590, Individual Retirement Arrangements, or the IRS Web site at

The foregoing information regarding personal, estate, charitable and/or business planning techniques is not intended to be tax, legal or investment advice and is provided for general educational purposes only. You should consult with your tax and legal advisor regarding your individual situation.

Contact Connie Dello Buono 408-854-1883 to have a 30-min chat with a financial advisor.

Conversion of Traditional IRAs to Roth IRAs

Roth IRAs (“Roth”) have been out of reach for many taxpayers because of income limitations imposed by the IRS. These same taxpayers have also been denied the ability to convert a Traditional IRA to a Roth IRA by a separate, but similar, income restriction. But the rules regarding conversion changed over time. Having the option to convert to a Roth may prove to be very desirable if you are a high income earner. It may also appeal to you if you have existing traditional IRA’s or qualified plan balances. Do you fall into either category?

Q1: What is a Roth IRA?

A1: Roth IRA’s were established by the Taxpayer Relief Act of 1997 and were made available to individual taxpayers in 1998. A Roth IRA allows taxpayers to create an IRA that is funded with non-deductible contributions. Roth IRA’s grow tax-deferred, and if basic requirements are met, distributions from the Roth IRA will be tax-free.

Q2: Are there income limitations for contributing to a Roth IRA?

A2: Yes. In order to contribute to a Roth IRA in 2012 there is still a Modified Adjusted Gross Income (MAGI) limitation. For 2012, the phase-out ranges are $110,000 to $125,000 for singles and $173,000 to $183,000 for married couples filing jointly.

Q3: If I complete a conversion, is the converted amount included in my MAGI?

A3: No. The amount converted does not impact the calculation of MAGI. In fact, you can convert to a Roth IRA even if you have no earned income. Note, however, that the conversion amount does impact the calculation for Adjusted Gross Income (“AGI”).

Q4: Is the conversion rule applicable only to Traditional IRAs or are there other types of accounts that can be converted to a Roth IRA?

A4: You can convert to a Roth IRA from a Traditional IRA, SEP-IRA or SIMPLE IRA (generally after 2 years of participation), 403(b) plan, 457 plan, and a qualified employer plan (such as a 401(k)/Profit Sharing Plan).

Q5: If I’m still employed and still covered under my employer’s qualified plan, can I convert part or all of my employer’s qualified plan balance?

A5: Generally, no. A triggering event (i.e. Retirement, Termination, etc.) would have to occur before a distribution could be made. However, if you are over the age of 59 ½, there may be an opportunity depending upon the type of plan under which you are covered. A distribution from a 401k or profit sharing plan to an active employee over the age of 59 ½ is generally permissible under the law, provided that the plan allows for such distributions. However, most plans don’t have this option. In addition, a 401(k) plan is generally prohibited from making any non-hardship distribution until the employee actually separates service from the employer.

Q6: If I convert to a Roth IRA and then my investments in that account go down, is there any way to reverse the conversion so I don’t pay taxes on higher values that are no longer there?

A6: Yes. This is called a “recharacterization.” Recharacterizations allow you to reverse the conversion as if you never did it. The rules around this are complex. Note that you have until October 15th of the year following the year you did the conversion to re-characterize it back to a traditional IRA.

Q7: If I re-characterize a Roth conversion, can I then RE-re-characterize it back to a Roth IRA?

A7: The answer is yes, but not in the same tax year. You must wait at least 30 days from the time you re-characterize back to a traditional IRA, and it can’t be any earlier than January 1 of the next year. For example, you convert a traditional IRA to a Roth IRA on September 1, 2012. Five months later your investments have dropped 25%. You can re-characterize the IRA as late as October 15, 2013. However, you won’t be able to convert this re-characterization back to a Roth until January 1, 2014.

Q8: Are there any other reasons besides market losses where I would consider a re-characterization?

A8: Yes. The following possibilities may cause you to consider re-characterization:

(a) you were counting on extra funds to be available to pay the taxes but they are not there;

(b) the added income of the conversion could disqualify a child from receiving college financial aid;

(c) an investment opportunity arose and you want the tax money back for that purpose; and/or

(d) an emergency occurs where the funds used to pay the taxes could now help.

Essentially, there are a number of possibilities where a re-characterization may prove helpful or even necessary.

Q9: What are the basic differences between AGI and MAGI?

A9: MAGI is derived from AGI. You would first calculate your AGI and then perform the required calculations as set forth on pages 2-3 of IRS Form 8606.

Q10: Can I convert an inherited IRA to a Roth IRA?

A10: No, unless you are the decedent’s spouse. However, if you are a beneficiary of a non-spouse’s qualified plan, you may be able to convert the inherited retirement plan assets directly to a Roth (see Q11).

Q11: I am the beneficiary of my uncle’s qualified retirement plan. If he were to pass away, could I convert the inherited retirement plan assets to a Roth IRA?

A11: Generally yes. Non-spouse beneficiaries can convert directly to a Roth IRA. There are other restrictions and rules, discussed below.

Q12. If I want to convert qualified plan balances that I inherit from a non-spouse, what should I be aware of?

A12: The Plan document must have a provision written into it that actually allows the conversion. If it doesn’t, then you will be forced to roll the qualified plan assets to a Traditional IRA first. Unfortunately, in that case, the conversion option will be lost because under current law, the conversion can only happen if it is a direct transfer (a/k/a “trustee-to-trustee” transfer) from the qualified plan. If you actually receive the distribution and then attempt to invoke the 60-day rollover rule, you won’t be able to roll those assets anywhere, let alone a Roth. You will have to pay taxes and possibly penalties on the amount received and you will have lost any opportunities to keep the account as any type of IRA. The law is very strict here. Barring a change in the law, your best chance if the Plan does not allow for this is to wait to see if either the Plan will be amended or if the law changes.

Q13: We currently file our income tax return as “Married, filing separately.” Will we be able to convert a traditional IRA to a Roth in 2012?

A13: Yes. Prior to 2010, married taxpayers who filed separately were not permitted to convert to a Roth IRA regardless of income.

Q14: Is there a “best time” to convert to a Roth?

A14: That would depend on your specific situation. If you want to lock-in your conversion now because of what you feel are depressed asset values, then it may make sense to convert to a Roth IRA. Additionally, if you convert early in the year and your assets drop significantly in value during the year, then you could re-characterize those assets back to a traditional IRA later in the year. A good time for that re- characterization may be around November of a given year so that if you wanted to then re-re-characterize back to a Roth IRA, you would only have to wait to January 1st of the following year. Also, you would probably have a good idea by then if there are any changes in the tax laws pending.

Q15: If I convert qualified plan assets to a Roth, whether they are my own or I inherited them, can I convert them into an existing Roth IRA that I have already established for myself? Does that make sense?

A15: You can do that but it may make more sense to create a separate Roth for these assets. A separate Roth IRA for qualified plan assets should make it easier to identify assets that came from particular sources. It should also prove to be less confusing if any questions regarding distributions arise. It may also give you greater distribution flexibility. In addition, if you are under age 59 ½ or aren’t disabled, it probably makes more sense to open a separate Roth IRA for each conversion you do (see next question).

Q16: After I convert to a Roth, how soon can I access the funds without penalty?

A16: The rules are different with conversions than they are with contributions. In general, for a Roth IRA that holds only contributions and investment income, you can always get your contributions distributed to you without tax or penalty (first in, first out). In order to access the earnings income tax-free and penalty tax-free, the Roth IRA must be at least 5 years old and you must be age 59 ½ or older (or disabled). Note that even if you have a Roth 401(k) and no other Roth account, the 5-year holding period doesn’t begin until a Roth IRA is established. With distributions from conversions, however, unless you are over age 59 ½, and the converted Roth IRA is over 5 years old, then you would pay a 10% penalty on the distribution – even though the distribution is not included in gross income. You may pay income taxes, as well, if part of the distribution consists of any gain. Essentially, each conversion creates its own 5-year window and thus must be treated separately from a traditional Roth IRA funded with just contributions.

Q17: I have a traditional IRA that has tax-deductible contributions and also post-tax contributions. I would like to convert just the post-tax portion to a Roth IRA. Can I do that?

A17: Unfortunately, no. The IRS says that you must consider the entire IRA for purposes of the tax effect of the conversion. For example, let’s suppose that your traditional IRA has a total balance of $100,000. Of that, $20,000 is from post-tax contributions and the balance is from tax-deductible contributions and investment gains. If you converted the $20,000 portion because you thought you could, the rules state that the conversion would be considered 20% tax-free ($20,000 divided by $100,000) and 80% taxable. In this case, you would have to report $16,000 of taxable income (80% of the $20,000 conversion).

Q18: Assume the same facts as the previous question but that I have 2 separate IRA’s: one IRA that was funded only with post-tax contributions and one IRA that was funded only with tax-deductible contributions. Can I convert just the post-tax IRA to a Roth IRA?

A18: Again, you cannot. You must look at all IRA balances – deductible and non-deductible – for determining the amount that you must include in taxation. So, even if the non-deductible IRA had exactly $20,000 (your contribution) and no investment gain, you still couldn’t convert that IRA only and escape income taxation. You would still have to report $16,000 of taxable income.

Q19: If I do take a distribution from a Roth IRA prior to the 5-year period, and if that Roth IRA holds converted amounts as well as original contributions and investment gains, is there any way I can avoid having to pay taxes or penalties on a distribution?

A19: Yes, but it depends on your age and the amount of the distribution you take. Distributions from a Roth IRA come first from contributions, then from conversion amounts, and finally from investment earnings. Let’s look at an example. In 2004, at the age of 35, you opened a Roth IRA with regular contributions. You proceeded to make contributions fairly regularly over the years. In 2012 you convert an existing traditional IRA worth $50,000 to a Roth IRA and you commingle it with your existing Roth IRA. In 2016, at age 47, your Roth IRA balance is $100,000 and is comprised of $25,000 of contributions, $50,000 of conversions, and $25,000 of investment gain. At that time you wish to take out $35,000 from the Roth IRA. What taxes would be due? First, there would be no income tax due. That is the result of the ordering process of how distributions are treated. The first $25,000 is a return of your contributions (no income taxes because contributions are made with after-tax dollars), and the next $10,000 is a return of your converted amount (also no income taxes because you paid income tax on the conversion). But, since the converted amount began its own 5-year window in 2013, and since 2016 is only 3 years after conversion, any amount taken from the conversion is subject to a 10% penalty tax (but no income taxes). So, even though you are taking a distribution of money that isn’t included as income, you are still going to pay a penalty because you are under age 59 ½ and because the converted amount isn’t at least 5 years old.

Q20: I’m over age 70 ½ and have already begun taking required minimum distributions (“RMDs”) from my traditional IRA. Am I eligible to convert a portion or all of my traditional IRA?

A20: Yes. The one thing to be aware of here is that the RMD for the year of conversion – if not yet taken – cannot be converted. Thus, many people take their RMD for the year and then convert.

Q21: A significant amount of my assets consist of qualified plans and tax-deductible IRA’s. If I convert any of these accounts to a Roth IRA, can I pay the taxes from those accounts as well?

A21: Yes, but it is generally not advisable. First, the withdrawal itself will be taxable. If you are under 59½, you’ll now owe penalties, as well. Also, the withdrawal will lose its ability to compound tax-deferred inside the plan or IRA. Conversion to a Roth IRA works best when the money needed to cover the taxes comes from sources other than the retirement plans or IRA accounts that were converted.

There is a significant opportunity for effective income tax and retirement planning by converting traditional IRAs and qualified plans to Roth IRAs. However, there are many rules and restrictions that must be understood and complied with. This memo is intended to educate you on some of these rules and restrictions. You should consult with your personal advisors and tax professionals before taking any action with regard to conversions or re-characterizations.

Contact Connie Dello Buono 408-854-1883 for a free 30 min chat with a financial advisor.


I’m Connie, financial advisor with Harding Financial helping doctors and business owners save $70k or more in income taxes per year via a financial strategy and business structure.  I can schedule a phone chat with you and our sr financial advisor this week.  Please email me at or


Connie Dello Buono

Harding Financial

Financial Advisor