Tax basis for IRA Conversion
I always use Turbotax (TT) to file my taxes. Tried to obtain info. from TT on how to figure out the tax basis for a partial Trad. IRA conversion to Roth IRA. Unfortunately, I received info. that the TT tax experts were not completely sure if it was correct. I have a complicated conversion because it involves both deductible and non-deductible amounts in my Trad. IRA.
. Here is my situation:
I am 62, my wife and I have contributed to IRAs for a very long time. Our total Trad. IRAs are valued around 800K (includes a large amount of an old 401K that was transferred to the IRA a while ago). The IRA includes about 10K in non-deductible contribution from a couple years that we did not qualify to contribute to the deductible IRA. In 2011, I converted about 40K from the Trad. IRA to the Roth IRA. I converted small amount to avoid paying too much taxes.
To determine my taxable basis for the 40K conversion: 10K / 800K= 0.0125
40K x 0.0125= 0.5K
40K-0.5K= 39.5K= taxable amount from conversion.
Am I correct?
BTW, I gotten different opinions from financial advisors on what amounts of the Trad. IRA to convert to Roth IRA. One said to convert the total amount, another said not to convert any, another said partial. I live in California and will have a very high taxable event for conversions. I know that by converting a high amount I will be subject to taxes of close to 50% (Fed.+ State). I did not feel comfortable doing this, although, one advisor said I would come out ahead in the long run.
What are your thoughts about possible ways to avoid the large taxation on the RMDs when we reach 70 1/2 years old?
Permalink Submitted by Peter Lingane on Tue, 2012-04-10 19:29
Basis recover is determined separately for married taxpayers. If you have $10K basis in your IRAs and the total value of your IRAs is $800K and you converted $40K, then your analysis is correct. But if you and your wife together have $10K basis and if the sum of both your IRAs is $800K, it is unlikely that your analysis is correct.
The California basis is sometimes different from the federal basis for those who have contributed to IRAs over many years.
I applaud your efforts to prepare your own income tax returns but you should recognize that there is a risk of error and that the error on a $800K conversion could be substantial. It would be prudent to have your returns professionally prepared every few years to confirm that you are doing things properly.
A professional preparer might be able to help you with your questions about the profitability of a Roth conversion. The answer depends on variables such as how you convert, what you spend in retirement in relationship to your income, what Congress does with the tax laws, how the market performs, when you die and what your heirs do with the money after you die.
Permalink Submitted by Bruce Steiner on Wed, 2012-04-11 22:30
It’s not surprising that a financial advisor wouldn’t be familiar with the Roth conversion.
At a constant tax rate, assuming you have enough non-IRA money to pay the tax, you would always convert, unless you intend to leave your IRA to charity. For example, suppose you have an $800,000 traditional IRA and $320,000 of other money, and you and your beneficiaries will always be in a 40% income tax bracket. You convert and use your $320,000 of other money to pay the tax. Over some period of time, your $800,000 Roth IRA doubles to $1.6 million, which you or your beneficiaries withdraw tax-free. If you don’t convert, your $800,000 traditional IRA will grow to the same $1.6 million, or $960,000 after taxes. If your $320,000 taxable account also doubled, it would grow to $640,000, and you or your beneficiaries would have the same $1.6 million total. However, your taxable account will grow to less than that, since the income and gains on it are taxable each year.
It gets more complicated if you or your beneficiaries expect to be in a lower tax bracket in the future. You have to decide whether to convert all at once, or over a number of years, and whether to convert (or begin to convert) now, or at some later time (or not at all if you expect to remain in a high bracket but your beneficiaries will be in a lower bracket). In that case, you could run some numbers, making some reasonable assumptions, or you could have the lawyer who handles your estate planning, or your accountant, run some numbers. Or you could try to do what appears to make the most sense.