IRA with Basis
Client has a $5,000,000 IRA with about $500K in basis. What is the tax treatment when he starts taking distributions?
Client has a $5,000,000 IRA with about $500K in basis. What is the tax treatment when he starts taking distributions?
Permalink Submitted by Alan - IRA critic on Tue, 2024-05-21 16:14
The only way to have that much basis is to have rolled over large amounts of after tax 401k contributions to the TIRA. And since 2014, any such rollovers should have split off the after tax amount in the 401k and rolled that to a Roth IRA.
In any event, the IRS instructions for Form 8606 indicate that the first 8606 otherwise filed after such an after tax rollover should list the added IRA basis on line 2. That would result in all subsequent distributions being pro rated on Form 8606. As such, a distribution taken with these figures would result in 90% of the distribution being taxable and 10% non taxable.
If client is still working for an employer whose 401k will accept IRA rollovers, he could roll 4.5mm (the amount in excess of the basis) to the 401k, and then convert the basis tax free to a Roth IRA. That would eliminate any future pro rating unless more after tax funds are contributed to the TIRA. It would also be tax efficient since 500k would be earning future non taxable gains in the Roth IRA, and the TIRA balance would be reduced by 500k, thereby reducing future RMDs. If the 401k rollover can be completed, after the year of rollover completion the 401k might allow the 4.5mm rollover to be rolled back out to the TIRA, which by then will no longer contain basis.
Permalink Submitted by Kevin Dempsey on Tue, 2024-05-21 17:01
Ok – Here’s more clarification because this is a 401(k) rollover situation. Client has a current TIRA of $516K with a basis of $81K. The 401(k) currently has $335K in “After-Tax” and $105K total in “Roth and Roth Catch-up”. So you’re saying when he gets the rollover checks the Roth check will be $440K, instead of just the $105K?
Also, so if there is no basis in the 401(k) pre-tax rollover, would it be advisable not to comingle the rollover into the existing TIRA that has basis?
Permalink Submitted by Alan - IRA critic on Tue, 2024-05-21 19:20
It’s fortunate that the 401k is still in place. Both the Roth balance (105k)in the 401k and the after tax non Roth balance (335k) should be directly rolled to the Roth IRA. The plan would probably issue two checks for these amounts, but they might also combine into a single check for 440k. If the checks are mailed to client he should be very careful to make sure they are deposited to his Roth IRA, and also be very clear ordering the direct rollovers because any confusion will be costly. Hopefully, there is a good plan administrator in place.
The pre tax 401k balance less the 335k should be directly rolled to his TIRA. None of these rollovers should be taxable, and Box 2a of the 1099R forms should be blank.
Of course, even if this is done correctly, he will still have 81k of IRA basis and will be subject to pro rating on Form 8606 when TIRA distributions are taken. But at least he would not be adding more to the IRA basis with the 335k doing to his Roth IRA.
Since all IRA accounts are treated as a combined single account for tax purposes, there is no reason not to roll the pre tax 401k amount into the current IRA unless he lives in one of the few states that do not provide good IRA creditor protection (eg CA).