Conversion of non-deductible traditional IRA to Roth IRA after investment income accumulates

I recently read that if you make a contribution to a nondeductible traditional IRA and let it sit until it accumulates enough investment income to exceed the full contribution amount for the tax year before you convert it to a Roth, you will have to reverse the “excess” amount of the conversion before the end of the year or be penalized by the IRS. Is this correct? It seems that if you let the contribution to a nondeductible traditional IRA sit and accumulate investment earnings (so the total of contributions plus investment earnings exceeds the IRS contribution limit for the year) before converting it to a Roth IRA, you would not run afoul of any IRS laws or regulations, you’d just simply be paying more tax on the Roth conversion (because of the investment earnings). Am I correct? Thank you.



Yes, you are correct. There is no excess contribution resulting from large gains, but if the original contribution was an excess contribution, you will owe taxes and penalty on all the gains if you remove the excess with earnings before the extended due date.  If this actually happened, you should NOT remove the excess before the due date because the tax and penalty would far exceed the 6% excise tax. Therefore, you would just remove the contribution amount itself before the end of the year following the contribution year and leave the significant gains in the IRA. Therefore, what you read is totally incorrect or perhaps you misinterpreted it.



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