Clarification Regarding "Traditional, SEP and Simple IRAs"

[XrayDoc88]

Over many years my wife and I have made contributions into our traditional IRAs.  Based on our income at the time, some of these contributions have been non-deductible.  We have kept track of our basis in each account.  We also each have a rollover IRA account from previous employer retirement plans.  Those accounts should have no basis.

We chose to convert our traditional IRAs to Roth IRAs in 2020.  When filling out forms 8606, part 1, line 6, are we supposed to include the year end values of our rollover IRAs?

[macuser_22 · Accepted solution]

Yes.  

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.

[XrayDoc88]

Thank you very much.  To make certain I understand correctly:

1.  A rollover IRA is just one type of a traditional IRA, even though it might have started as a 401K plan?

2.  When you are making a conversion from a traditional IRA that has some basis to a Roth IRA, you are essentially taking a distribution from the traditional IRA, and you get a prorated credit for the basis in the distribution?  In other words, the income tax I have to pay on the distribution (conversion) will actually be slightly less than the full amount converted because of my partial basis?

3.  That's why part 1 of form 8606 needs to be filled out, to calculate your partial basis in the distribution?

I must have missed a step by step instruction in TurboTax or just misunderstood that a rollover IRA is a traditional IRA.  Our 8606 forms for 2020 only had part 2 filled out and we paid income tax on the full conversion amounts with no credit for a non-deductible basis.

I sure wish the IRS would just add the term "Rollover IRA" to "Traditional, SEP and Simple".  I'm sure I'm not the first to be confused by this.

[Critter-3]

The term "rollover IRA" is an industry term not an IRS one ... it designates that it came from a 401K and if you have a new job with a 401K who allows the old 401K money to transfer in then you know which IRA you can move it from ... nothing more than that.  Once the money left the 401K and was put into an IRA then to the IRS it is just an IRA. 

[fanfare · Accepted solution]

If you did not use the prior years basis, then the prior years basis remains the same as it was.

You don't have to amend.

OR 

you can amend your return to file a correct 8606 and get a refund.

depending on the relative size of your basis, the difference could be significant or insignificant.

[fanfare]

As I understand it ,once you made a contribution into a Rollover IRA, it ceased to be a Rollover IRA.

Also as I understand it, this distinction regarding rollovers back into a 401k no longer has meaning due to Tax Code changes.

In any case, you're better off getting out of a 401k rather than into a 401K, since an IRA has more flexibility.

But with a 401k your employer may match some percentage of your payroll contribution.

The employer is not going to match anything you roll in.

If you have a 401k (retirement plan) at work you may or may not be able to deduct an IRA contribution.