How to compute backdoor Roth IRA capital gains?

Forum|Forum|5 years ago
February 24, 2021
8 replies
51 views

I contacted Fidelity because I wanted to return the distribution of my traditional IRA back to my non-retirement account and they told me that I will pay taxes plus 10% penalty on the gains from the contributions that I have made from last month. They suggested that why not do a backdoor contribution to my ROTH IRA and that way I will only pay taxes on the capital gains.

My question is how do you compute the capital gains from the contributions that I made last month if you do a backdoor ROTH? I contributed $6k and they said it has a capital gain of more than $400 even though the cash was just sitting in my IRA account. They said the IRS taxes me on the whole capital gains of my IRA account.

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dmertz

Level 15

CFR 1.408-11 describes the entire calculation: https://www.law.cornell.edu/cfr/text/26/1.408-11

The calculation is performed over the investment performance of the entire IRA, not just the particular investment in which the contribution being returned was originally invested. In the simplest case, if the entire IRA gained, say, 7% in value while the contribution being returned was in the account, the gains attributable to the contribution being returned is equal to 7% of the amount being returned. For example, if you contributed $6,000 and the value of the entire IRA went up 7%, a return of the $6,000 is required to be accompanied by $420 of earnings for a total distribution of $6,420 from the IRA. That $6,420 can come from any of the investments in this IRA account.

Fidelity will do the earnings calculation for you based on the IRA value on the date of the distribution of the return of contribution and earnings. You'll just need to tell Fidelity from which investments to make the distribution.

The earnings distributed ($420 in the example above) will be subject to income tax and, if you are under age 59½, to a 10% early-distribution penalty.

marysblossomAuthor

Level 2

Thanks for replying. If I do the Backdoor Roth, should I transfer the $6000 contribution plus the capital gains from the traditional IRA or just the $6000? Is there a article at Turbotax on how to do this on my Turbotax software?

dmertz

Level 15

In my previous reply I should have said that a return of your traditional IRA contribution or recharacterization of your traditional IRA contribution to be a Roth IRA contribution instead has nothing to do with a backdoor Roth. Recharacterization simply makes it as if the original contribution had been made to a Roth IRA, meaning that you must be eligible to have made the Roth IRA contribution based on your filing status and modified AGI for the purpose of a Roth IRA contribution.

You didn't say why you were considering a recharacterization.

If you were ineligible to contribute to a Roth IRA because your MAGI is too high, you can get money into a Roth IRA by doing a Roth conversion from your traditional IRA. The original traditional IRA contribution, would remain a traditional IRA contribution and the Roth conversion would be a separate transaction. The taxable amount of the Roth conversion would be calculated on Form 8606.

If you are eligible to have made a Roth IRA contribution for 2020, it would be more beneficial to do a recharacterization than to do either a Roth conversion or a return of contribution.