Roth Conversion and proposed rule changes
The proposals currently in discussion at the Federal gov’t regarding Roth Conversion of non-deductible IRA contributions may end conversions after of Dec. 31, 2020. But, what does that actually mean? For example, in a Traditional IRA account, which has grown substantially over many years from both deductible contributions and non-deductible contributions (cost basis is tracked on form 8606), ….what is actually being limited under the proposal? Does it mean you can convert partial amounts from the account’s growth (earnings) and/or from the deductible contributions made many years ago, but not from the contributions that were non-deductible? Or does it limit ALL conversion amounts from the account because SOME of the contributions were non-deductible, and SOME of the growth was due to non-deductible contributions? What about amounts from the account that were already converted to Roth in past years that used up some of the initial cost basis? How does that impact the contribution amounts attributed to non-deductible years? Thank you for any insight. Of course the proposals may change or or not pass into law, but trying to plan ahead before year end…!!
Permalink Submitted by Alan - IRA critic on Wed, 2021-09-22 23:47
It would mean that your IRA basis tracked on Form 8606 could not be converted at all. The pro rate rules of Form 8606 would no longer apply, and all conversions would be 100% taxable, and not otherwise restricted. Conversions done in year prior to the adoption of new provisions would not be affected, and basis applied to those prior conversions would not be changed. If you think this will be passed into law effective January, 2022 and you have a meaningful basis in your TIRA and an employer than that accepts IRA rollovers, you would seriously consider rolling the pre tax balance of your IRA into that plan ASAP, then converting your IRA basis before year end. It might be the last chance to get your basis into a Roth IRA.
Permalink Submitted by ray perez on Thu, 2021-09-23 03:34
Thank you. The TIRA is not through an employer. This is an individual TIRA for a self employed person. Additionally, there is a substantial SEP-IRA account that increases the total year end combined account values used in 8606 calculations for Roth Conversions.In prior years small amounts from the TIRA and SEP were converted to Roth, but those 8606 calculations used up very little of the cost basis due to the high year-end combined account values.To clarify, did you mean that only the amount that is tracked as a cost basis could not be converted, but the rest of the money in the TIRA could be converted? Example:total year end value of all TIRA and SEP accounts: $500,000. Original deductible contributions to the TIRA: $12,000. Original non-deductible contributions (tracked on 8606) to the TIRA $11,000 (or $16,000 if you consider previous recharacterizations from Roth to TIRA as non-deductible)Would it be allowable to convert $500,000 – 11,000 = $489,000 ? (or $500,000 – 16,000 = $484,000 ? (I realize the tax bill would be very high, but I’m just trying to understand what’s allowed.)One additional question: does any of the Roth conversion (proposed) restrictions impact conversions from SEP accounts? All SEP contributions were deductible (or were converted from TIRA to SEP many years ago).
Permalink Submitted by Alan - IRA critic on Thu, 2021-09-23 15:46
Being self employed, if there are no other employees other than a spouse, the only solution to eliminate pro rating is to adopt a solo K plan for 2021, roll the SEP and the pre tax amount of the TIRA into the solo K before year end and then convert the IRA basis tax free. I don’t know if all this is worth the effort for 16,000 of TIRA basis unless the higher contribution limits of the solo K is attractive. A full conversion as is would produce a very high tax bill and is therefore also not viable. The proposals treat a SEP IRA exactly the same as a SIMPLE IRA or TIRA account. They could be converted at will (2 years waiting period for a SIMPLE), but not the TIRA basis, so any conversion under the proposal would be 100% taxable. I wouldn’t assume this provision will pass as is as the compliants are already being heard since the back door Roth is so popular.
Permalink Submitted by ray perez on Thu, 2021-09-23 18:19
Thank you for your reply. We both agree that a full conversion is unwise due to a huge tax bill.Assuming the provisions do pass as is, (though the bill is likely to be revised before anything actually passes) there would be no restrictions in future years on conversions to Roth of small amounts each year (so as not to have a huge tax bill in any single year), from the TIRA and/or the SEP, except for the $16,000, correct? The earning/growth and the deductible contributions are not restricted in future years, correct? Only the $16,000 must stay as TIRA. The SEP can be converted in small amounts annually, in future years, as it was all deductible in the contribution years.
Permalink Submitted by Alan - IRA critic on Thu, 2021-09-23 20:49
That is correct. Future conversions will be allowed but will be 100% pre tax IRA money and 100% taxable. The IRA basis of 16,000 cannot be converted under the proposed version of this bill. Future conversions could come from either the SEP IRA or the TIRA, except that 16,000 must remain in non Roth IRAs.