Roth Conversions

[kramzepol]

Hello. In 2023 I will complete the conversion of my traditional IRA to Roth IRA. Next, I plan to begin rollovers and partial Roth conversions from my 401k (pre-tax TSP account), beginning 2023, keeping within my current tax bracket. I am concerned about the IRS pro-rata rule. Would it be wise to rollover and convert some of my 401k funds in 2023, thus commingling my pre-tax 401k and after-tax non-deductible trad. IRA funds, or should I complete conversion of my trad. IRA in 2023 and begin rollover and partial Roth conversions from my 401k in 2024?  I am 62, retired and reside in MA.  Am I overthinking this? What would you do?  Thank you!

[Cindy4]

Hi kramzepol!

Thanks for joining us today.

Depending on the amount of earnings that may be forgone by delaying the Roth conversion, I may delay that until the tax impact is equal to or lower than the earnings that may be gained.  Distributions sent to multiple destinations at the same time are treated as a single distribution for allocating pretax and after-tax amounts for the pro-rata rule. 

"To roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), and directly roll over:

• pretax amounts to a traditional IRA or another eligible retirement plan, and
• after-tax amounts to a Roth IRA.  "

From this IRS resource:  https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans

If the TSP is all pre-tax, the rule doesn't seem to apply.  Sending the amount you withdraw from the pre-tax TSP to a Roth, would all be taxable to the extent your total income level exceeds the standard or itemized deduction.

Hope this helps!

Cindy

[K M W]

Great question about moving funds from a pre-tax retirement account to an after-tax retirement account!

If I understand your question correctly, you have a 401k account with all pre-tax contributions, a Traditional IRA account, and a Roth IRA account. You have started moving funds in 2023 from the Traditional IRA to the Roth IRA, and now want to start moving the 401k balances  to ultimately end up in the Roth IRA account.

In a simplified situation, if all your contributions to the Traditional IRA were deductible contributions, then you can proceed in any order you wish - i.e. you can move the 401k to the Traditional IRA, then move those funds to the Roth IRA, knowing that the total amount you move from the Traditional to the Roth will be taxed in the year you move the funds to a Roth IRA.

However, it seems based on your question that you may have mixed contributions in your Traditional IRA currently - that is, some contributions that were deducted on tax returns, and some contributions you made when your income was too high, so they are non-deductible contributions.  if this is the case, then your IRA account has a mixture of pre-tax and after-tax dollars in it.

if you choose to move part of your Traditional IRA balances to a ROTH IRA, then the IRS says you have to calculate the amount of the funds moved over that represents the pre-tax amount and the after-tax amount. You must do this in a pro-rata manner, based on the relative percentages of deductible and non-deductible contributions in the account.

However, you may be able to skip a step to the Traditional IRA completely, as the IRS does allow a rollover from an employer plan into a Roth IRA.  You can roll over into a Roth IRA all or part of an eligible rollover distribution you receive from your (or your deceased spouse's):

• Employer's qualified pension, profit-sharing, or stock bonus plan (including a 401(k) plan);

• Annuity plan;

• Tax-sheltered annuity plan (section 403(b) plan); or

• Governmental deferred compensation plan (section 457 plan).

Any amount rolled over is subject to the same rules for converting a traditional IRA into a Roth IRA. 

You must include in your gross income distributions from a qualified retirement plan that you would have had to include in income if you hadn’t rolled them over into a Roth IRA. You don’t include in gross income any part of a distribution from a qualified retirement plan that is a return of basis (after-tax contributions) to the plan that were taxable to you when paid.

In your situation, it may be easier moving the funds directly from the 401k to a Roth IRA, as you would know the exact dollar amount that will be taxed to you in the year you move the funds.

For more information on moving funds from your 401k directly to a Roth IRA, see IRS Publication 590-A, page 44.

[kramzepol · Accepted solution]

Thank you KMW. Great answer! You mostly understood my confusing question. To date, all of my Roth conversions were made from my non-deductible traditional IRA account. Under the pro-rata rule I have enjoyed not having to pay federal taxes on approximately 35% or more of the converted funds. All of my non-deductible after tax traditional IRA has been converted to Roth this year; however, I figure I can still convert another $50k this year from my pre-tax GOV TSP/401k account in 2023 without moving into the next tax bracket. I’m trying to reduce future RMDs and want to convert as much as I comfortably can to Roth before I turn 75. If I elect to convert both pre-tax TSP and after-tax non-deductible trad. IRA to Roth IRA in 2023, in essence, would that just affect the pro-rata %, causing more of my conversion to be taxed?  In addition to wanting to convert more to my Roth, as indicated, I also don’t want to create any more confusion for myself during tax filing season. Thank you so much!

Mark 

[K M W]

Thanks for clarifying the question!  If you wanted to keep it simple, the eastist and cleanest answer is to wait until 2024 to move the 401k to the Roth account.

However, with that being said, I don't see anything in IRS Publication 590-A that would indicated you have to use the pro-rata rules on moving non-deductible IRA funds to the Roth IRA in the same year you move your 401k funds to the Roth.  The pro-rata rules only seem to apply when there are deductible and non-deductible contributions in any and all Traditional IRA accounts. In fact, the form used to calculate the pro-rata amount taxable in the transaction is Form 8606 - Nondeductible IRA's.  In that form's instructions for part 2, it covers conversions from Traditional, SEP or SIMPLE IRA's to Roth IRA's, and rolling amounts from a 401k to a Roth IRA is not reported on this form.

So, if you rolled your 401k into your Traditional IRA which also has non-deductible contributions in it, then you would have apply the pro-rata rules. But if you rollover from an employer's plan to a Roth IRA, that is treated as a totally separate rollover from the IRA to Roth IRA converstions.

[dmertz]

If your first contribution (including conversions) to a Roth IRA was for some year before 2019, your Roth IRAs are qualified and any distributions from your Roth IRAs in 2023 and beyond are free of tax and penalty.  It doesn't matter how the money got into your Roth IRAs.

If your first contribution to a Roth IRA was for 2019 or later, to be able to take out tax-free any earnings that have occurred within the Roth IRA you'll need to wait until 5-years have passed from the first year for which you made a Roth IRA contribution.

[K M W]

dmertz, a little clarification to your response;  a distribution from your Roth IRA is totally tax free If it is a Qualified Distribution. To be considered a qualified distribution, you must have held a Roth IRA for five years AND the distribution is:

• Made on or after the date the taxpayer reaches age 59 1/2, or
• Made due to the taxpayer's death or disability, or
• For a qualified first-time home purchase ($10,000 lifetime limit).

So merely holding a Roth IRA for 5 or more years does NOT make the entire amount available to be withdrawn tax free, if you don't meet the rules listed above. For example, a person (not disabled, not a first time home buyer) who is under 59 1/2 but held the Roth IRA for over 5 years and takes a distribution is considered to have made a nonqualified distribution, and may have to pay taxes and the 10% early withdrawal penalty on the taxable amount of the distribution (unless an exception to the penalty applies). Of course, you have to apply the ordering rules to determine what part (if any) of the distribution is considered a taxable amount. Generally speaking, the ordering rules state that distributions come first from regular contributions (tax and penalty free and can be withdrawn at any time), then from conversions and rollover contributions, then from earnings.