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?
Comments
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.
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.
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.
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.
@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
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
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.
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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/
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.
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
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
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.
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.
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.