Roth IRA conversion

[rart942]

I have before tax and after tax contributions in separate IRA's that are more than 5 years old. I want to convert part of the before tax IRA to a Roth IRA. I am 60 years old.

1. Does the pro-rata rule apply in this instance?

2. Does the 5 year rule apply to the funds converted to the Roth IRA?

3. Any other considerations?

[dmertz · Accepted solution]

1. Yes.  When determining the taxable and nontaxable amounts of a Roth conversion, your IRAs are treated in aggregate.  The age of your traditional IRAs is not relevant.  The fact that you made your nondeductible traditional IRA contributions to any particular IRA is irrelevant.  The pro-rata calculation is done on Form 8606 using the total of your nondeductible traditional IRA contributions previously reported on your most recently filed Form 8606 (and any current-year nondeductible contributions, if any), the amounts of your conversions and other traditional IRA distributions and the total of the year-end balances in your traditional IRAs, if any amounts remain. 
2. Since you are over age 60, any distribution you receive is free of any early-distribution penalty.  The 5-year rule for conversions does not apply since it is only used to determine if the conversion amount is subject to an early-distribution penalty when distributed from the Roth IRA before age 59½.  However, there is a different 5-year rule that is used to determine if earnings that occur in your Roth IRAs are tax free, qualified distributions when distributed.  This 5-year rule is satisfied 5 years after the beginning of the year for which you first make a Roth IRA contribution.  If your first Roth IRA is established by a Roth conversion in 2018, distributions occurring after 2022 will be qualified distributions, entirely tax free no matter how much is distributed from your Roth IRAs.  Until then your tax-free distributions are limited to the converted amounts plus any regular Roth IRA contributions you might have made.  Under the ordering rules for Roth IRA distributions, earnings are distributed last.
3. To maximize the benefit of a Roth conversion, pay the taxes on the conversion with other, after-tax funds, rather than using a retirement-account distribution to pay the taxes.  By paying the taxes with other funds you maximize the amount that you get into Roth IRAs to be able to grow tax free (once your Roth IRAs are qualified).  In doing this, decline tax withholding on the Roth conversion and, if necessary to avoid a tax underpayment penalty, make an estimated tax payment.  If you have taxes withheld from the traditional IRA distribution that is being converted to Roth you'll have to come up with funds from another source to complete an indirect Roth conversion of the portion withheld for taxes.
   

[rart942]

Thank you for your reply. I neglected to say that I will be transferring the funds to a Roth IRA that was established more that 10 years ago. What effect does that have on the 5 year rule you mentioned? 3. Any other considerations for the conversion?

[dmertz]

Since you are over age 59½ and it has been more than 5 years (the 5-year rule for qualification) since the beginning of the year for which you first contributed to a Roth IRA, *any* distributions you receive from your Roth IRAs will be qualified distributions, tax and penalty free, including those deriving from Roth conversions no matter when the Roth conversion took place.  As I mentioned in #2 above, the 5-year rule for conversions (a different rule from the 5-year rule for qualification) does *not* apply since you are over age 59½.  (I've edited that statement above to make it clearer.)

[Intchk]

Using form 8606 I had contributed to non-deductible IRA  prior to availability of ROTH IRA. I would like to convert to ROTH IRA. Since I have another traditional IRA( this account deductible amount), if I convert this deductible traditional IRA to ROTH IRA  during this year 4th quarter, do I still need to do pro-rata calculation on non-deductible IRA if I convert this non-deductible  to ROTH in 4th quarter as well ? Was thinking since I converted my only taxable IRA to ROTH IRA, no need to pro-rata and pay no tax this year for this non-deductible amount.

Thanks

[macuser_22]

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@Intchk wrote:

Using form 8606 I had contributed to non-deductible IRA  prior to availability of ROTH IRA. I would like to convert to ROTH IRA. Since I have another traditional IRA( this account deductible amount), if I convert this deductible traditional IRA to ROTH IRA  during this year 4th quarter, do I still need to do pro-rata calculation on non-deductible IRA if I convert this non-deductible  to ROTH in 4th quarter as well ? Was thinking since I converted my only taxable IRA to ROTH IRA, no need to pro-rata and pay no tax this year for this non-deductible amount.

Thanks

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@Intchk-

The answer to your question is no - the basis is always prorated over the aggregate value of all existing Traditional, SEP and SIMPLE IRA accounts.

There is no such things as a "taxable" or "non-taxable" IRA - your IRA consists of the aggregate value of all IRA accounts.

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.

[Intchk]

Thank you for reply and information!

Appreciated!

Regards

[Mike7388]

I have a follow-up question on your response.  You specifically mention that the aggregate of Traditional IRA's, SEP and Simple accounts should be added together.  I want to confirm whether or not that aggregate balance should also include "Roll-over IRA's" (rolled-over from a Company 401k Plan).  Also, when is the aggregate basis calculation performed as-of; December 31'st of the year the conversion (which would therefore require adding-back the conversion amount into the denominator), or as of December 31st of the year prior to the conversion?  Thanks.

[macuser_22]

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@Mike7388 wrote:

I have a follow-up question on your response.  You specifically mention that the aggregate of Traditional IRA's, SEP and Simple accounts should be added together.  I want to confirm whether or not that aggregate balance should also include "Roll-over IRA's" (rolled-over from a Company 401k Plan).  Also, when is the aggregate basis calculation performed as-of; December 31'st of the year the conversion (which would therefore require adding-back the conversion amount into the denominator), or as of December 31st of the year prior to the conversion?  Thanks.

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For the purpose of determine the year end value of all Traditional IRA, SEP and SIMPLE IRA's to determine the taxable amount on the 8606 form then yes, ALL existing such IRA's must be included reguardless of where the funding came form or if it was a rollover or not.

(BTW some taxpayers attempt to do a so called "backdoor Roth" and overlook a prior 401(k) rollover IRA which will make most of the backdoor conversion taxable because the year end value will be high rather then zero.)

[richard103]

Referring to the following statement from dmerz (point #2 in his / her response from Jun 5, 2019)

"...However, there is a different 5-year rule that is used to determine if earnings that occur in your Roth IRAs are tax free, qualified distributions when distributed.  This 5-year rule is satisfied 5 years after the beginning of the year for which you first make a Roth IRA contribution.  If your first Roth IRA is established by a Roth conversion in 2018, distributions occurring after 2022 will be qualified distributions, entirely tax free no matter how much is distributed from your Roth IRAs.  Until then your tax-free distributions are limited to the converted amounts plus any regular Roth IRA contributions you might have made.  Under the ordering rules for Roth IRA distributions, earnings are distributed last."

Can anyone please point me at a definitive statement, from either the IRS or TurboTax, that documents his / her point?

Here's my situation, and the way I'm interpreting dmerz' comment:  I'm well over 59 1/2, so no issue there.  I have one Roth IRA account.  It was initially funded back in 2014 by a TIRA conversion, so from that standpoint I'm past the 5-year period, but I should note that I've made subsequent TIRA conversions and tax-paid 401K rollovers to it, including even in 2021.  If I'm reading dmerz' opinion correctly though, I should be free to withdraw any and all money, including my basis and any earnings, from that Roth account here in 2021.  I.e. all money in the account is now considered "qualified" by the IRS.  

I guess I should say first: If I'm not reading that right, please let me know, and...

...Again, assuming I am reading it right (and that dmerz is correct), if anyone can point me at definitive documentation of dmerz' (and my) interpretation, either from the IRS or TurboTax, I'd appreciate it.

[macuser_22]

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@richard103 wrote:

Referring to the following statement from dmerz (point #2 in his / her response from Jun 5, 2019)

"...However, there is a different 5-year rule that is used to determine if earnings that occur in your Roth IRAs are tax free, qualified distributions when distributed.  This 5-year rule is satisfied 5 years after the beginning of the year for which you first make a Roth IRA contribution.  If your first Roth IRA is established by a Roth conversion in 2018, distributions occurring after 2022 will be qualified distributions, entirely tax free no matter how much is distributed from your Roth IRAs.  Until then your tax-free distributions are limited to the converted amounts plus any regular Roth IRA contributions you might have made.  Under the ordering rules for Roth IRA distributions, earnings are distributed last."

Can anyone please point me at a definitive statement, from either the IRS or TurboTax, that documents his / her point?

Here's my situation, and the way I'm interpreting dmerz' comment:  I'm well over 59 1/2, so no issue there.  I have one Roth IRA account.  It was initially funded back in 2014 by a TIRA conversion, so from that standpoint I'm past the 5-year period, but I should note that I've made subsequent TIRA conversions and tax-paid 401K rollovers to it, including even in 2021.  If I'm reading dmerz' opinion correctly though, I should be free to withdraw any and all money, including my basis and any earnings, from that Roth account here in 2021.  I.e. all money in the account is now considered "qualified" by the IRS.  

I guess I should say first: If I'm not reading that right, please let me know, and...

...Again, assuming I am reading it right (and that dmerz is correct), if anyone can point me at definitive documentation of dmerz' (and my) interpretation, either from the IRS or TurboTax, I'd appreciate it.

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IRS Pub 590-B

https://www.irs.gov/publications/p590b

You only have one Roth IRA that can consist of any number of accounts so the term "Your Roth IRA" it refers to the aggregate total of all Roth IRA accounts.

[partial quote]

What Are Qualified Distributions?

A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

1. It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and

2. The payment or distribution is:

   1. Made on or after the date you reach age 59½,

   2. Made because you are disabled (defined earlier),

   3. Made to a beneficiary or to your estate after your death, or

   4. One that meets the requirements listed under First home under Exceptions in chapter 1 (up to a $10,000 lifetime limit).

   Distributions of conversion and certain rollover contributions within 5-year period.

   If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or roll over an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You must generally pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount). A separate 5-year period applies to each conversion and rollover. See Ordering Rules for Distributions , later, to determine the recapture amount, if any.

[richard103]

FYI I found a really-slick tool the IRS provides that asks you fairly-simple questions and then tells you if any portion your Roth IRA Distribution is taxable (non-qualified).

• You reach it by going to IRS.gov. Type ITA (Interactive Tax Assistant) in search box. First returned entry says “recommended by IRS – Interactive Tax Assistant (ITA). Click on that link.

• Simply scroll thru the topics listed on 1st page of ITA. You'll see a section called Retirement. Under it you'll see a line saying “Is my Roth IRA distribution taxable?”. Click on that.

• Here's the straight-up link fyi https://apps.irs.gov/app/IPAR/screen/IPAR_1/en-US/summary?user=guest