ROTH IRA Question

VintageFreak

So I have a situation I can't figure out.

I have an IRA. This IRA was invested in before there was anything like the ROTH IRA. However, this IRA was invested with after-tax dollars. In other words, my wife was eligible to invest in an IRA, not eligible to do it pre-tax since she also had 401k which was pre-tax.

Questions
1) Can we convert this IRA to a Roth IRA without having to pay any taxes now, since IRA was not invested with any pre-tax dollars?
2) Even if answer to 1 is "No", since it was invested with pre-tax dollars (and at freakin' wrong time), current value is not much higher than total invested. So if I convert to Roth IRA, perhaps I can deduct cost basis and pay penalty only on remaining amount for Roth conversion?

LLJB

Sorry I'm not an expert but I also have after tax dollar in an IRA together with pre-tax money I rolled over from a previous employer's 401k. My understanding is that the after-tax contributions gives me, and your wife, a "basis" in that IRA. Just like when I eventually take distributions and I won't have to pay tax on everything I believe your wife would only pay tax on whatever gains are in the account if she does a Roth conversion.

Based on the research I've done about converting my rollover IRA to a Roth I also don't believe there's any penalty, just whatever tax is due on the gains you covert to the Roth.

Hopefully someone is able to confirm my opinion because I probably wouldn't want to rely on it alone.

VintageFreak

@LLJB. If at least I can confirm the penalty is only on the gains after cost basis, that'll be good. However, it would be really nice if there is not even that penalty since the IRA was funded with after tax dollars anyways.

I've tried to get this clarified reading Roth IRA conversion rules, but this situation is not addressed anywhere that I can find. Hoping someone can provide some guidance.

Finally, there remains the item of proving your cost basis, whether for Roth IRA conversion right now, or whenever I sell out the IRA. Because I'm thinking even if I let money stay in current IRA when I sell it, I should not have to pay deferred taxes on the entire withdrawal since after all I have a cost basis on which taxes were already paid. I did put this in my tax returns so it shows up I have a cost basis.

LLJB

Here's some info from the IRS that doesn't specifically answer the question but would be interesting if you wanted to get all the after-tax contributions out of the IRA and into a Roth while moving whatever gains are there into another pre-tax plan.

https://irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans

I didn't follow any of the other links on the page but my guess is that you might find specific answers about the tax implications and/or penalties in one of those links.

The tax returns and Form 8606, which is used to report after-tax contributions to the IRS is all you need to prove your basis. I believe, but I'm guessing a little, that brokers or trustees have to report the value of retirement plans to the IRS annually or at least when there's a distribution so the IRS can calculate what portion of the distribution you should be paying tax on.

Dolphin

Converting a non-deductible IRA to a Roth IRA is straightforward if you have no other IRA assets. The taxable portion is only on the gains since the contributions have already been taxed.

However, it's rarely a good idea if you have other traditional IRAs. Total balances of all your IRAs are used to determine the taxable amount of your Roth IRA conversion.

jerry

Dolphin is correct but if I note you have a good deal of money in traditional iras + the money in a nondeductible ira you may be able to roll the traditional ira money into a 401k and the handle the non deductible ira as discussed

VintageFreak

@LLJB. So my wife has a 401k and ONLY this 1 piddly IRA. Form 8606. Will make note thanks.

@Dolphin Can you clarify what you mean by "no other IRA assets"? Like I said my wife has a 401k and then this 1 IRA only. Not many IRAs.

I will ready up that link soon. Hopefully it answers my questions. I've been trying to get clear answer for 3 months

bee

Another great resource that I actually read daily is Ed Slott's IRA Discussion Board. You can submit your own question or scan through questions already posed by readers.

Main discussion link:
https://irahelp.com/forums/ira-discussion-forum

Here's an example of a Q posed that seems close to yours:
https://irahelp.com/forum-post/28462-transferring-after-tax-ira-after-tax-401k-then-roth-ira

msf

The link is a nice try, but is talking about something different - money in employer-sponsored plans (e.g. 401(k)s). With all due respect to LLJB, I think you might be advised to ignore it, at least for now. Especially given your question asking to clarify whether 401(k) assets count in this IRA question.

Short answer - they don't; that's why I'm suggesting you pay no attention to 401(k) rules for now.

The only way your wife's 401(k) plan could mess with the IRA Roth conversion is if your wife rolled over the 401(k) money into an IRA (the existing one or a new one) before doing the conversion. Don't do that, and you're fine.

Dolphin's got it exactly right.

==========

Other details include:

- Since this is wife's first Roth IRA, she'll have to wait five years to get post-conversion earnings out without taxes
- If converted money is withdrawn in less than five years and wife is under 59.5 at the time, then there's an extra penalty. (The reason is that this is viewed as a backdoor for getting money out of the original IRA before age 59.5, which would have that penalty.)

Here's a description of the general 5 year rule for all Roths (explaining the first item above):
http://fairmark.com/retirement/roth-accounts/roth-distributions/tax-free-distributions-from-roth-iras/

Here's a description of the Roth conversion/early withdrawal penalty issue (second item):
http://fairmark.com/retirement/roth-accounts/roth-distributions/distributions-after-a-roth-ira-conversion/

Old_Skeet

For what it is worth ...

I hold non qualified contributions in my traditional ira ... and, now that I am taking annual distributions these non qualified contributions reduce my tax libality. I leave this up to my tax accountant to compute all of this because it really, for me, is complicated.

msf

I think you mean non-deductible contributions. In Roth IRA leagalize, "qualified" generally refers to "distributions" (withdrawals). Distributions are said to be qualified if they meet the five year rules and you're over 59.5 or meet some exception.

https://www.irs.gov/publications/p590b/ch02.html#en_US_2016_publink1000231061


"Qualified" is also used to describe employer plans that satisfy section 401(a) of the tax code (e.g. 401(k) plans). A completely different subject.

http://www.360financialliteracy.org/Topics/Retirement-Planning/Retirement-Planning-Basics/What-does-the-term-qualified-plan-mean

msf

I think I see where people are getting confused with 401(k)s. VF gave too much info.

Wife made non-deductible contribution to "piddly IRA". That's the current state of affairs, it doesn't matter how she got there.

The back story (which is irrelevant) is that wife decided in the past to make the non-deductible contribution because there's a rule saying you can't deduct a contribution to a traditional IRA if:
(a) you are participating in a plan at work such as a 401(k), and
(b) your income exceeds $119k in 2017.

https://www.irs.gov/retirement-plans/2017-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work

rforno

I still can't shake the feeling that until the IRA contributions can be made in sums equal to that of 401/403/457s ($18K vs $5500 per year) they may well be a joke down the road and/or don't allow people to save away enough for retirement. Yes, I contribute to mine each year, but if you CAN contribute more - up to a certain limit - why shouldn't we, especially if you're in a job that LETS you be a responsible saver and tuck away more while you can? Heck, if you suddenly are able to contribute $18K to an IRA while you're in a good-paying job, that can put you ahead of things if for some reason you lose that job and/or are later unable to contribute much to your retirement future. In this case, it's like you're being penalised for trying to be a responsible person and thinking proactively about your future needs.

Long story short every now and then I just think the whole IRA/Roth IRA thing is a nice thought but may not be very helpful -- or more trouble than they're worth. Ridiculous contribution limit aside, the various loopholes / hoops you have to jump through with retirement accounts, conversions, limits on contributions, required withdrawls, etc .... it's crazy.

Dolphin

@VintageFreak - what i meant is, your 401K is not considered an "IRA asset" - at least for now. It remains a 401K until you decide to convert it. So it's irrelevant in terms of your non-deductible IRA to Roth conversion.

VintageFreak

Sorry guys, but I'm still not clear on my situation. Let me read up and I'll come back...

billr

I think Dolphin nailed it. If you have no other IRAs, then just roll this one into a Roth IRA and you'll just pay the income tax on the gains that have taken place. The actual deposits move for free.

401k holdings don't apply at all UNLESS you roll those into an IRA. Then suddenly this little IRA becomes only a part of your total IRA holdings.

I once had this type of IRA also. When I cashed it out to buy a house, the tax due was only on the increase in value. Same concept as rolling it over.

VintageFreak

@billr. Sorry I guess I didn't understand @dolphin post. This is perfect. I SHOULD roll it over to Roth IRA. It's at Scottrade so maybe best I just visit the local office.

I don't need to prove to Scottrade what my cost basis is right? I have to do it next year when I file my taxes? Basically asking if the penalty I'm paying has to be at time of conversion or at time of file taxes next year.

Also clarifying "you have no other IRA". Not sure I understand the significance. I have an IRA and my wife has an IRA. We also have 401ks. While my IRA was an old 401k rolled over to IRA, my wife's IRA was one started with after tax dollars. THIS latter IRA is the one I'm trying to convert to Roth. I trust that should be fine, yeah? Or is MY IRA guilty by association?

Sorry if I'm being stupid. I think I will sell what I own in this IRA get it converted ASAP.

billr

Your IRA and your wife's IRA are separate so that's ok. It is only if you or she have multiple, then they get treated as one bigger one by the IRS.