Commingled IRAs – Convert to Roths?
In 2001, a husband and wife commingled each of their non-deductible IRAs with each of their IRA rollovers. It is unclear as to whether they can obtain the original basis, but let’s assume they can. The commingled assets were subsequently invested in a combination of individual stocks and bonds, mutual funds, and ETFs.
Fast-forward eleven years, the husband has retired and is taking his RMDs from his rollover and using them to fund Roths for himself and his wife (after passing through trust accounts). The wife is still working but plans to retire this August. At that time she plans to rollover her 403b plan into her existing rollover.
The husband now wants to convert the non deductible portion of the rollover to Roth IRAs.
1. How do they determine the amount of the non-deductible that can be converted to Roths?
2. How do they segregate basis from earnings?
3. Assuming questions one and two can be answered and that the conversion makes sense, would it be better to convert next year when the wife will have retired and their income drops?
Any help would be greatly appreciated!
Permalink Submitted by Jose Morales on Thu, 2012-03-29 16:12
You cannot convert only the non-deductible portion of your overall IRA in order to avoid taxation. The taxable amount of the conversion will be the proportion of their overall IRA balance that is non-deductible. As an example, if all of the IRAs they have total $100,000 and $40,000 of that is non-deductible contributions then 40% of the conversion will be tax free.
Permalink Submitted by mk foss on Thu, 2012-03-29 16:39
Determining basis should be easy. They were required to file Form 8606 with every nondeductible contribution – the running total should appear on each spouse’s Form 8606 for the last year that they made a nondeductible contribution. If they didn’t file the required Form 8606s – they need to find the information and file them ASAP.
The idea that the retired spouse is running RMDs through a trust account is troubling. Roth conversions come from retirement accounts not trust accounts. A Roth contribution can come from any source but thre are limitations based on earned income and adjusted gross income.
The RMD cannot be converted to a Roth so that part of the explanation was also confusing to me.
Ursei2 is correct in his response; I agree with him (her?).
Permalink Submitted by Bubba Franks on Fri, 2012-03-30 13:28
Thank you urusei2 and mgtf4cpa for your helpful replies.
Re urusei2’s response: Just to clarify, are the Roth balances included in the calculation of overall IRA balances (I imagine so)? Are the earnings on the non-deductible contributions convertible too? If so, how would one go about calculating the earnings on just the non-deductible portion? . . . or am I not thinking about this correctly?
Re mgtf4cpa’s response: As you mentioned, the RMDs are used to fund contributions and are not conversions per se. My understanding of the rules verified by the client custodian’s IRA department is that first, the RMD must land in some kind of an account (e.g., checking, personal, trust, etc.). From there it can be used to fund Roth contributions for each spouse. My apologies for the lack of clarity.
Permalink Submitted by Jose Morales on Fri, 2012-03-30 17:53
The Roth balances are not included in the calculation of the overall IRA Balances when determining the ratio of the taxable vs. non-taxable conversion amount. Are you using the term “non-deductible contributions” as a replacement for “Roth IRA Contribution?” It is technically correct, however it will cause confusion because you can also make non-deductible contributions to Traditional IRAs. So to be clear, you must use your entire Traditional IRA value (the balance of every Traditional IRA you have, without any segregation of earnings from contributions whether they be deductible or not) to find the ratio of the taxable vs. non-taxable conversion amount. You would not calculate the earnings on just the non-deductible portion. The forumula would look like this:
Non-deductible Traditional IRA contributions/Entire Traditional IRA Value = Percentage of conversion amount not subject to tax
As an example:
$40,000/$100,000 = .40 or 40%
So now lets say you choose to convert $20,000 this year…
$20,000 x .4 = $8,000 of the conversion which is not subject to tax