calculating taxes on a roth conversion
A question on how to calculate taxes on a Roth conversion:
Example 1:
John has 2 retirement accounts.
A 401(k) with a current balance of $100,000.
An IRA with a current balance of $100,000.
$20,000 of John’s 401(k) contributions were non deductible and reported on Form 8606.
John wants to convert the $100,000 in his IRA account to a Roth.
As I understand, 10% of the $100,000 will not be subject to tax. John will report and pay taxes on $90,000 of income.
Is this the right calculation?
Example 2:
John has 3 retirement accounts.
A 401(k) with a current balance of $100,000.
An IRA with a current balance of $100,000
A Roth IRA with a current balance of $100,000.
John wants to convert the $100,000 in his IRA to a Roth IRA.
The Roth account represents 33% of the total portfolio ($33,000 of the $100,000 conversion).
Does this mean John only reports and pays taxes on $66,000 of the conversion . ($100,000 – $33,000)
How do you calculate the taxes due when a Roth retirement account is part of the existing portfolio?
thanks
Permalink Submitted by Alan Spross on Thu, 2010-08-05 16:44
Kathy, you mentioned an 8606 in Example 1, but the 8606 applies only to IRAs, not to a 401k. Now, if you meant that 20,000 of the IRA contributions were non deductible, then 20% of his IRA conversion would be tax free.
If the 401k account also includes after tax contributions, those are NOT combined with IRA non deductible contributions on the 8606. If a direct conversion is done for the 401k funds, the tax free amount is only affected by the amount of after tax contributions in that particular 401k account.
Example 2: Neither the Roth IRA or the 401k affects the taxes on a conversion from a TIRA. If the TIRA contains non deductible contributions per Form 8606, the tax free % will be the 8606 figure divided by 100,000. The other two accounts are not relevant.
Permalink Submitted by kathleen Lane on Thu, 2010-08-05 19:01
thanks for the answers.
As I read your answer, it appears the tax calculations for converting an IRA do not need to include any existing 401(k) accounts.
Can you convert a 401(k) account? How would the tax calculations work in this situation?
Thanks
Permalink Submitted by kathleen Lane on Thu, 2010-08-05 19:03
one other questions:
how and when do you track/report after-tax contributions to a 401(k)?
thanks
Permalink Submitted by Alan Spross on Thu, 2010-08-05 19:48
Yes, a qualified retirement plan (401k, 403b, 457) can be directly converted to a Roth IRA without having the funds move through a TIRA account. If there are after tax contributions in a plan, the plan administrator must track them (not the taxpayer) and report them on a 1099R. The after tax basis is distributed pro rata with pre tax amounts, with the exception of pre 1987 after tax contributions, which can come out separately. The taxpayer reports these direct conversions directly on line 16 of Form 1040. There is no 8606 used.