Are there tax implications of mixing pre and post tax dollar in Traditional IRA when converting post tax dollars to Roth IRA?

[sdarora]

I have Traditional IRA that was converted from 401K employer few years ago. So the money in this account in pre-tax.

I am not eligible to contribute to Roth IRA because of income limitations.

Two questions:

1. Can I put new money which is after tax into Traditional IRA and convert all of that new money  to Roth IRA? Are there tax implication for mixing pre-tax and post-tax money? 

2. If there are implications or of the tax returns are going to be complicated, Can I create new Traditional IRA just for this purpose and then convert money from new account to  Roth IRA? Will it be not considered as mixing pre and post tax money and should not have any tax implications? Will it simplify tax returns?

[macuser_22]

Yes there are.  If the per-tax money is much more than the after-tax money then moat of the distribution will be taxable and only a small part not taxable.

You can NEVER withdraw ONLY the nondeductible part - it must be prorated over the entire value of ALL Traditional IRA accounts which include SEP and SIMPLE IRA's. (For tax purposes you only have ONE Traditional IRA which can be split between as many different accounts as you want, but for tax purposes they are all added together).

For example using rough figures: if you had $60K of nondeductible contributions in an IRA with a total value of $600K (10:1 ratio), then when you take a $60K distribution from any IRA account $6,000 would be nontaxable and $54,000 would be taxable (same 10:1 ratio) , with the remaining $54K of basis staying in the IRA for future distributions. As long as there is any money in the IRA, there will be some basis.

TurboTax will ask for your non-deductible "basis" and then the *Total Value* of *all* Traditional IRA, SEP and SIMPLE accounts as of Dec 31, of the tax year. That is so the prorating of the basis can be properly proportioned between the current years distribution and the remaining IRA value. That is done on the 8606 form.

[sdarora]

That is not the answer I got from Fidelity but you are the expert that's why I asked here. 

I am still confused. So, I will share exact numbers so I will appreciate if you can help me understand

I have 95K in Traditional IRA (pre-tax money). Last contribution I made into this account was several years ago.

Now, I want to put 6K (2020 limit) in this account which will be post tax money and then convert that 6K into Roth IRA.

Do I pay taxes on 6K that I took out from Traditional IRA?

[dmertz]

The nontaxable amount of the $6,000 Roth conversion will be $6,000 * $6,000 / ($95,000 + $6,000) = $356.44 and the taxable amount will the $6,000 - $356.44 = $5,643.56.  $5,643.56 of your basis in nondeductible traditional IRA contributions will remain in your traditional IRAs to be applied to future distributions.

[sdarora]

Are you saying only 365.44 will move to Roth IRA and 5643.56 will stay in Trad. IRA? 

[dmertz]

No.  $6,000 moves to the Roth IRA, but only $356.44 of your basis applies to the conversion and reducing the taxable amount slightly, with $5,643.56 of basis remaining in your traditional IRAs to reduce slightly the taxable amount of future distributions.  You'll always have some basis in your traditional IRAs until your traditional IRAs are fully distributed, with the last of your basis applied to the final year's distributions.

[sdarora]

Still not following. Too complicated to understand, and what is "basis"? I wish there was an easier way for a non tax professional to figure this out. I keep hearing Backdoor IRA which is described as (at least whatever I read), if you make more than the given income limits for Roth IRA, then put money in Trad IRA and convert that to Roth IRA the same year. And you can not take tax deduction on money you put in Trad. IRA. 

But doesn't look like that is true. 

[dmertz]

Basis is the amount of nondeductible contributions you have in your traditional IRAs.  Your basis nondeductible traditional IRA contributions, in this case $6,000, is rationed out in your distributions in proportion to the overall value of your traditional IRAs.  That ration for your $6,000 distribution form the traditional IRA valued at $101,000 after the contribution would be $356.44.

The "backdoor Roth" method only works as desired if you have no other money in traditional IRAs.

[macuser_22]

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@sdarora wrote:

Still not following. Too complicated to understand, and what is "basis"?

But doesn't look like that is true. 

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Basically "basis", "after-tax money" and "non-deductible contribution" all describe the same thing.    When you make a Traditional IRA contribution, you can choose to deduct it from your taxable income (which will usually lower the tax or increase the refund) or choose not to deduct  it.   Some times because of income limits you are not allowed to deduct it.

In either case, that means that the contribution that was not deducted has already had the tax paid on it since you did not deduct it, so when withdrawn that "after-tax" (basis) will not be taxed again.   But as I posted earlier in this thread, you can NEVER ONLY withdraw that after-tax basis.  It must always be prorated between the current distribution and the aggregate total of all IRA accounts.      In your case, since your current distribution is only a small portion of the total IRA value, then only a small portion of the after-tax basis can be applied to reduce the tax on the distribution.

You can see that calculation on lines 6-15 on the 8606 form that will be part of your tax return.