As I mention earlier my friend is single and her income is over 125,000. Based on previous correspondence she is not allowed to have a Roth IRA ,or contribute any amount to Roth Ira either directly or by conversion to begin with.
You are correct that she is not allowed to make Roth IRA contributions because of AGI limitations. But because there is no AGI limitation - she is allowed to convert into Roth IRA funds previously contributed to the traditional IRA. There is no income limits on conversions.
I personally prefer Roth IRA because of some advantages
- mainly - earnings will be never taxable AND - there will not be RMD after age 70 1/2.
You have a valid point that if she has both deductible and nondeductible IRAs - she would not be able to separate them for conversion purposes - and converted amount will include both taxable and not taxable portions. That is because taxable portion in case on conversion is determined the same way as for distribution purposes.
However - assuming she will be taxed on distribution anyway - conversion might be beneficial in sense to avoid tax liability on earnings.
Spreading tax liability from conversion was only allowed in 2010 - that option is not available anymore.
How much to convert depends on current and prospective taxable income
There are other issues to consider - for instance if the person receives social security - part of it might be taxable - so additional taxable income might trigger additional social security benefits to be included into taxable income. In this case we might plan larger conversion in the year before starting social security benefits.
You have a very valid point - but as we see such planning
is very specific to individual circumstances.
There is a good point in the referenced article about isolating nondeductible IRA funds - however most 401k and 403b plans do not accept funds from IRA. But the idea is nice and definitely worth to try.