Did I Just Make My Roth Conversion of Basis Taxable? Any way Out? Sorry for the Long Post – Its Complicated

Submitted by clay massey on Fri, 2019-04-12 17:10

Fidelity’s Pitch:

In late 2016, I was contacted by a representative of Fidelity, my company 401 K provider, to see if I was interested in rolling my IRA from Vanguard to a Rollover IRA with them. The purpose of this was to allow me to perform a Roth conversion without any tax consequences. This would be done by rolling only the taxable funds in the new Rollover IRA into my 401K , leaving my basis of $59K that came from non deductable IRA contributions over the years (IRS Form 8606 Line 14, ). This remaining basis in the Fidelity Rollover IRA could then be converted to a Roth IRA. When I filed my taxes for 2018 and filled out the form 8606, on Line 6 where it asks for the value of all my traditional IRAs as of 12/31/18, I would then be able to put in $0, since all my IRA funds had been rolled over into my 401K. This would take the pro rata rule out of play and the entire $59K conversion would not be taxable.

Roll taxable IRA Funds to 401K, Convert Non Taxable Basis to Roth

This sounded good to me, so in late 2016 and early 2017 I rolled my IRA from Vanguard to a Rollover IRA at Fidelity. On 1/12/98, we started the rollover of all my taxable funds in My Fidelity Rollover IRA into my company 401K (also with Fidelity) to isolate my basis of $59K. They then converted those funds to a Roth IRA.

The Problem

In April 2018 I was laid off from my job. I was fortunate to get a very generous several package. In September of 2018, after reading about the pros and cons of leaving my 401K at my company, I decided to roll my 401k (which now had my former IRA funds) back to Vanguard. I had to call Fidelity to do this, and they did try to get me roll the funds back to my Fidelity IRA instead of Vanguard because they didn’t want to lose this significant amount of money. Unfortunately, They didn’t mention the tax implications of rolling my 401K money into any IRA since I had done the Roth conversion in 2018, namely, that I would now have to report very large IRA balance on Form 8606 Line 6, which would make all of my $59K rollover of my basis taxable.
Best I understand, since Roth recharacterizations are prohibited under the new TCJA tax plan, I am stuck with this huge increase in my taxes for 2018. Am I missing something? Is there a way out? Thanks for any help or comments anyone might have.

Skidude



Submitted by David Mertz on Fri, 2019-04-12 18:37

  • There is no undoing this.  There is nothing you can do now but pay the taxes.
  • Although it’s probably not the case, if you are eligible to make a deductible Traditional IRA contribution for 2018 and have not done so, a deduction for a traditional IRA contribution could be used to offset a little bit of this unexpected taxable income.

Submitted by Alan - IRA critic on Fri, 2019-04-12 18:42

  • Unfortunately, since 2018 is over you are stuck with the mostly taxable conversion which cannot be recharacterized. Not sure why you made this mistake, but am guessing you probably thought that after the conversion was done you could roll the 401k back to the IRA and not affect the conversion being non taxable. But you would have had to wait until 2019 to roll pre tax dollars back into the IRA for the non taxable conversion to be preserved. 
  • Some of your conversion should still be non taxable since you had 59k of IRA basis. For example, if the 12/31/2018 balance of your TIRA was 531k, then 10% of your conversion would be non taxable since 5,900 of your basis would be applied to the conversion, leaving you with 53,100 basis still in your TIRA. 
  • Due to the severance package, your income was probably about the same as 2017 plus 50-60k of additional conversion income. The lower tax rates of 2018 will help you somewhat, but not enough to offset the taxes.
  • Since you will still have a large TIRA basis (line 14 of your 2018 8606) to apply in the future, you may have another chance of pulling this off correctly, but you will need a new employer plan that accepts IRA rollovers.

Submitted by clay massey on Sat, 2019-04-13 01:36

Thanks your time in reading and responding to this post.  Date was supposed to be 1/12/18, not 98.

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