Post and pretax IRA gains
I have a client that has a post and pretax IRA. The client contributed around $300k into the post tax IRA some time ago and it has gains of $200k. The client transferred his accounts to me. The previous administrator transferred the $300k post tax amount in one check but put the $200k gains from the post tax IRA into the pre tax IRA. Since all gains are taxed at ordinary income it should matter, right? Or does it?
Thanks,
Andy
Permalink Submitted by Alan Spross on Wed, 2011-07-13 00:27
It does not matter because any gains are combined with post tax basis and pro rated upon any distribution including a conversion. Ordinary income rates apply to the taxable portion of any IRA distribution.
Even if the client had a fully pre tax TIRA from a rollover or from deductible contributions and a totally separate IRA account holding only non deductible contributions, the combination of those accounts into one IRA account would not affect upon the taxation of distributions.
I don’t know how the administrator knew what the post tax amount was unless they were provided with that info by the client. IRA custodians have no idea how much basis exists in an IRA account. That info is only known by the IRS and the taxpayer as documented on Form 8606.
In any event, the transfer mechanics do not matter with respect to current or future taxation. If the checks were not made out to the client, then the funds moved by a non reportable transfer and there would be no 1099R or 5498 and the client would not report the transfer on his tax return.
Permalink Submitted by Andrew Wasa on Wed, 2011-07-13 00:42
So are you saying that even the post tax contribution will be taxed at ordinary income when it comes out? And are you saying that we don’t need 2 separate accounts? We can combine it? We set up 2 accounts.
The administrator new because the client told them when he transferred it there. The checks were made out to the new custodian.
Thanks,
Andy
Permalink Submitted by Alan Spross on Wed, 2011-07-13 00:56
Only the pre tax share of any distribution will be taxable. With the breakdown you stated, only 40% of any distribution will be taxable. This applies whether the funds are combined in one account or in separate accounts, so there really is no need for separate accounts.
Since the client could not have accumulated 300k of non deductible contributions, if this amount is correct if must have come from the rollover of after tax contributions from an employer plan such as a 401k. Most critical is that the client needs to report any after tax contributions to an IRA on Form 8606. And the 8606 is also the form that calculates the taxable amount of any distributions.
If client has an after tax basis of 60% of his IRA, it may be wise to make some Roth IRA conversions since only 40% of any conversion will be taxed and any gains in the Roth will be tax free once the Roth is qualified.
Permalink Submitted by mk foss on Wed, 2011-07-13 01:02
The basis (after tax contributions) will always be tax free but you cannot withdraw them separately. If %500k is the total of all IRAs and the post tax basis is $200k, the if $1,000 is withdrawn from the post-tax IRA – $3,000 is taxable as ordinary income and $2,000 is tax free. All distributions are prorated whether they are in one or more accounts. For distribution purposes all IRAs, including SEP and SIMPLE IRAs are treated as one.
No tax problems are created by combining the accounts. Some people keep rollover IRAs separate because there is an advantage in the case of bankruptcy. I assume that the post tax IRA was created by a rollover. After-tax IRA contributions have only been allowed since 1987 and it isn’t possible to have $200k in contributions alone.
Permalink Submitted by Andrew Wasa on Wed, 2011-07-13 01:36
Thanks for the detailed explanation. The post tax contribution amount of $300k is what he told me. It make sense that it is almost impossible to contribute $300k. I will find out the exact amount and post it. All I know is he transferred $1.7mm and it’s currently divided $200k in the post tax and $1.5mm in the pretax. He told me that he contributed $300k in the post tax with gains of $200k and the rest is in the pre tax. I’ll find out and repost.
Thanks,
Andy