Basis for the Roth conversion (pro rata rule)

Submitted by peter hsi on Mon, 2017-09-04 16:05

Hi,
First i want to say this is one of the best place for IRA information that i have seen. So, thanks you. I am retired and thinking about how to best manage my retirement accounts. I hope you can help me with my question. I have a traditional IRA (#1) and a company sponsored 401K/pension. My tradition IRA #1 account is funded by after tax money (i.e. 100% non-deductible contribution over time). Whereas, my 401K/Pension are all from pre-tax money. I want to convert 100% of my tradition IRA #1 to Roth IRA (e.g, on 1/1/2018). I also want to convert my company 401K/pension to a new traditional IRA (#2), e.g. on 12/1/2018, 11 months late but in the same tax year. I believe since IRA #2 is created after I distribute all of IRA #1, I don’t have the pro rata basis rule issue. Say it differently, i don’t have to include IRA #2 when calculating my 2018 taxable income due to the Roth IRA conversion. My taxable amount will be the difference between IRA #1 market value on 1/1/2018 and IRA #1 cumulated basis as of 12/31/2017. Am I right? Again, appreciate your thoughts.
Peter

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Permalink Submitted by Alan - IRA critic on Mon, 2017-09-04 16:32

Unfortunately that is incorrect. The taxable amount of an IRA distribution (includes conversions) is determined using Form 8606 and all IRA values as of year end, which would be 12/31/2018 for a 2018 conversion. The rollover to IRA 2 would increase the taxable amount of the conversion, probably substantially. The taxable amount is NOT determined as of the date of the conversion. Check Form 8606, line 6 to see how this occurs.
Therefore, you need to complete the conversion in the calendar year prior to the year of the 401k rollover. If you do the conversion in 2018, then postpone the 401k rollover until Jan, 2019. Or if you do the conversion before the end of this year, you can do the 401k rollover in January, 2018.
Hopefully, you filed Form 8606 for each year in which you made the non deductible contributions, since that accumulated total goes on line 2 of the 8606 used to report your conversion.