Attention: Retirement savers in Illinois, Kentucky, Oklahoma, and nine other states — if you are contributing to a Roth IRA, you may save hundreds of dollars in state income tax if you use an alternative strategy that I call deduct-and-convert.
Not everyone qualifies but it’s worth checking if you live in those states. The strategy involves making a contribution to a traditional IRA and immediately converting from the traditional IRA to a Roth IRA.
I didn’t invent this strategy. The inspiration came from the poster Bob’s not my name on the Bogleheads investment forum. Bob’s not my name credited it to another poster bdpb. Because the procedure is similar to Backdoor Roth, Bob’s not my name calls it Backdoor Both. I think deduct-and-convert describes it better.
What Is Deduct-and-Convert?
Deduct-and-convert is a different way to contribute to a Roth IRA. If you qualify, you will save hundreds of dollars in state income tax when you first contribute to a traditional IRA and then convert (not recharacterize) from the traditional IRA to a Roth IRA immediately.
Who Qualifies for Deduct-and-Convert?
You must live in the right state and have the right income to qualify for Deduct-and-Convert. You also must want to contribute to a Roth IRA to begin with.
Live In the Right State
You must live in a state that exempts some income from an IRA distribution from state income tax. Some states give it to all taxpayers. Some only give it to people above a certain age.
| Minimum Age | $ Cap (if less than IRA contribution limit) | |
| Arkansas (AR) | 59-1/2 | Â $6,000 |
| Colorado (CO) | 55 | |
| Delaware (DE) | None | $2,000 if under age 60 |
| Georgia (GA) | 62 | |
| Illinois (IL) | None | |
| Iowa (IA) | 55 | |
| Kentucky (KY) | None | |
| Mississippi (MS) | 59-1/2 | |
| New York (NY) | 59-1/2 | |
| North Carolina (NC) | None | $2,000 |
| Oklahoma (OK) | None | |
| South Carolina (SC) | None | $3,000 |
Six states — Illinois, Kentucky, Oklahoma, Delaware, North Carolina, and South Carolina — give the exemption to all taxpayers, although the latter three have a dollar cap lower than the annual IRA contribution limit. Six other states — Arkansas, Colorado, Georgia, Iowa, Mississippi, and New York — only give the exemption to taxpayers above a certain age.
If you live in other states, sorry, no deduct-and-convert for you.
State laws change. Make sure to double-check with tax form instructions and publications from your state’s tax authority to confirm that the state still exempts some income from an IRA distribution from state income tax.
Have the Right Income
You must have enough taxable compensation (“earned income”) to contribute to an IRA. This minimum income requirement is the same for both Traditional IRA and Roth IRA. Investment income, retirement income, and Social Security benefits don’t count. The income must be taxable compensation for your work (a job or self-employment).
You also must qualify for a tax deduction on contributions to a traditional IRA. This maximum income qualification depends on your total income and on whether you are covered by a workplace retirement plan, and if you are married, whether your spouse is covered by a workplace retirement plan. The IRS lists the maximum income in IRA Deduction Limits. I also have them in Deductible IRA Income Limit.
Why Should I Use Deduct-and-Convert If I Qualify?
If you qualify for deduct-and-convert, you get a tax deduction on your state income tax when you first contribute to a traditional IRA. When you convert the traditional IRA to a Roth IRA, the income from the conversion (subject to the dollar cap, if any) is exempt from state income tax when you live in one of those right states.
If you simply contribute directly to a Roth IRA, you don’t get a tax deduction on your state income tax. Therefore deduct-and-convert lowers your state income tax compared to a direct contribution to a Roth IRA.
How exactly do I deduct-and-convert?
Step 1 – Contribute to a Traditional IRA
Open a Traditional IRA at the same place where you have your Roth IRA. If you already have a Traditional IRA there, you can use the existing account. Make a contribution to the Traditional IRA as usual.
Although you have until April 15 to make the contribution for the previous year, it’s easier if you complete the contribution and the conversion before December 31 in the current year. That way both the deduction and the conversion appear on the same tax return.
Step 2 – Convert from the Traditional IRA to Roth IRA
If you opened a new traditional IRA, just convert the entire balance in the Traditional IRA. If you used an existing account, convert the amount you contributed. Different IRA custodians have different procedures for this. Some let you do it online. Some ask you to fill out a paper form. If you don’t know the procedures, ask them.
Make sure you use the right terminology when you deal with the IRA custodian. You want to convert from the Traditional IRA to a Roth IRA, not recharacterize your contribution from Traditional to Roth. There’s a difference and the difference is important.
There is no minimum waiting period for the conversion. If your custodian is administratively capable, you can convert on the next day after your contribution is received. If your contribution must clear first, the wait is usually less than a week.
Step 3 – Claim a Deduction on Your Federal Tax Return
Tax software will automatically claim the deduction for you when you tell it that you contributed to a Traditional IRA and the software sees that your income qualifies for a deduction. The deduction on the federal tax return also reduces your state income tax when you live in one of the right states.
Step 4 – Report the Roth Conversion on Your Federal Tax Return
You will receive a Form 1099-R from the IRA custodian next year when you convert from a Traditional IRA to Roth. When you enter the 1099-R into tax software, the software will generate Form 8606 and make it taxable because you are taking a deduction for the contribution. The deduction and the taxable conversion come out to a wash on your federal income tax, but the conversion income will be exempt from your state income tax if you live in those states and you meet the age requirement if your state has one.
It’s too much work!
If you are doing it for the first time, maybe. If you follow the steps, it’s not that hard. The second time will be easier. The third time will be a breeze. It’s up to you whether you want to save hundreds of dollars a year. Think of it as a free iPad if it helps motivate you.
Should I Leave It as Traditional and Not Convert?
That’s a whole different question. Deduct-and-Convert assumes that you want to contribute to a Roth IRA. You end up at the same place as making a direct contribution to a Roth IRA but you save hundreds of dollars in state income tax along the way.
Leaving it in the Traditional IRA and keeping the federal income tax deduction may very well be a better strategy depending on your income trajectory. If you question the wisdom of contributing to a Roth IRA in the first place, please read my previous post The Forgotten Deductible IRA.
Reference: Backdoor Both — have your cake and eat it too, Bogleheads.org
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KD says
My AGI may fall between the IRA limits, and I have already contributed to the full limit to a Roth for this year. I still need to figure out my MAGI. I am wondering how much is it worth for me to re-characterize the Roth, make traditional contribution, take partial deduction and convert back to roth and to put the nondeductible portion directly in to roth. Lots to think about.
PS: Sorry about the spamming problem from my email. I fixed it. Hope it works.
serbeer says
And if one converts larger amount (eg $50K) accumulated in TIRA account during number of previous years, in a state without caps, say IL, will this amount be sheltered from state income tax as well?
Harry Sit says
@serbeer – The lack of an entry in the “$ cap” column in my table doesn’t necessarily mean that the state doesn’t have a cap. Many states still have a cap but the cap is higher than the $5,000/person IRA contribution limit ($6,000 if over 50). Now, for Illinois specifically, it doesn’t have a cap. If you convert $50k when you a resident of Illinois, it will be taxed on the federal tax return but not on the Illinois state tax return.
serbeer says
Thanks TFB. Sounds like a loophole to me.
If you simply withdraw it from TIRA without converting to Roth, you will pay IL state tax in addition to federal tax. But if you convert to Roth first, you are not taxed by state.
I think IL is going to close this loophole as soon as legislature realizes it is there. Similarly to how they now recapture 529 state tax deduction if money are withdrawn for non-qualified expenses.
Do you agree?
Harry Sit says
@serbeer – Illinois doesn’t tax traditional IRA withdrawals. It treats a Roth conversion the same as a withdrawal. See Illinois Revenue Publication 120. Federally taxed income from IRAs is subtracted before calculating Illinois state income tax.
Jonathan says
This does seem like an interesting way to save on state income taxes for some people. Isn’t a possible con against this practice that you won’t put “more” money into a Roth IRA? Putting $5,000 pre-tax and then converting is “less” than a $5000 after-tax contribution.
Harry Sit says
@Jonathan – After you convert, you still have $5,000 in your Roth IRA. You don’t pay any tax out of that $5,000. The taxable income from the conversion and the tax deduction wash out each other on your federal tax return; on the state return you get a deduction but no taxable income. You are basically making a $5,000 after-tax contribution.
Jonathan says
Aha, you are correct, I should have known after my own conversion.
JJ says
TFB, I am asking to many question to you tonight since I am doing my tax now 🙂
I can’t do this in Turbotax. My state is Illinois.
In Turbotax I specified that my wife contributed $5000 to her traditional IRA account, and I could see both my federal and state tax refund went up.
As soon as I specified that my wife re-characterized $5000 to her Roth IRA, both federal & state refund went down.
What did I do wrong?
Harry Sit says
JJ – Since you mentioned Illinois in the other post, I was going to point you here but you got to it first! What did she do in 2011?
If she contributed to a Traditional IRA (eligible for a deduction) and later she recharacterized the contribution to a Roth IRA, then what you are seeing is correct, but she didn’t follow the strategy in this post. The title says deduct-and-convert, not deduct-and-recharacterize.
If she contributed and then converted, you shouldn’t have told TurboTax she recharacterized. See How To Report Backdoor Roth In TurboTax on how to report a contribution followed by a conversion.
If she only contributed in 2012 for 2011 but she converted or will convert in 2012, you only report the contribution for 2011 but wait until next year for the conversion part.
JJ says
TFB – Thanks for the clarification.
I misunderstood recharacterize vs conversion.
She contributed in 2012 for 2011, and she will convert in 2012.
So, for now I will only report the contribution for 2011, and wait until next year tax season to report the conversion.
Is that right?
Thanks again.
Harry Sit says
JJ – That’s right. You will get a deduction (refund up) for 2011. You will pay federal tax on the conversion for 2012. Depending on your tax rate, you may also want to leave the money in her traditional IRA. Read the last paragraph in the post and the link to another post.
Brian says
Harry, I am looking to see whether I qualify for this strategy for tax year 2015, as I have not made my IRA contribution yet.
If I contributed to a solo 401k in 2015, does that make me covered by a workplace retirement plan?
Harry Sit says
Brian – It does.
Daniel says
I would like to confirm that this is still available in Oklahoma for both the 2016 tax year and the upcoming 2017 tax year.
Brian says
I think I’ve made a $675 mistake not utilizing this option in 2016–perhaps you can confirm.
My income was low in 2016. Because of that, I decided to contribute $18,000 to my solo Roth 401k instead of traditional. Now I’m thinking that I could have made the $18,000 contribution to my solo traditional 401k, gotten the federal and Illinois tax deduction, then converted $18,000 from my traditional IRA (where I have plenty of money) to my Roth IRA, of which I would only pay federal income tax. Net, I believe I could’ve saved myself $18,000 times the 3.75% Illinois tax rate.
prs says
Hello All,
Great article and step by step explanation. Just one thing I would like to add to it – such converted funds are locked for 5 year period. I mean, usually roth contributions can be freely withdrawn, but these converted funds can not be taken out for 5 years at least.