after tax money and roth iras
I have a client with 180 pre tax and about 20k after tax. It is my understanding he can roll the pretax to his IRA. Per IRS notice 2014-54, the IRS authorized tax free roth conversions of after tax money. How would this work in his situation? I don’t get how it would work in reality. What tax implication would he have if the 20k is already after tax? Just the gain on the after tax money? Anything special we would need to do or just open a Roth and have the after tax money mailed to the new custodian? Thanks so much.
Permalink Submitted by Alan - IRA critic on Thu, 2015-03-26 17:43
Notice 2014-54 allows client do request two rollovers where the 180 would go to a TIRA and the 20k to a Roth IRA. But 180 is such a small amount, client should opt for the simplicity of just ordering a direct rollover of the entire amount to a Roth IRA. The 180 will be reported as taxable income in Box 2a of his 1099R. A direct rollover will avoid 20% withholding on the 180 (36) which would need to be replaced with other funds, so it is more efficient do have a direct rollover done. Note that the 5 year conversion holding period only applies to the pre tax money (180), so if he withdrew the conversion before 5 years, the 180 would come out first and be subject to the 10% penalty. But the entire non taxable portion of the conversion could be withdrawn without penalty.
Permalink Submitted by Robert Ervolina on Thu, 2015-03-26 20:59
Ok thanks. How is the 20k treated for tax purposes? I assume it isn’t taxed at all correct and can be withdrawn at anytime? Woudln’t that come out before the 180k or is it considered conversion money too? I thought if client were over 59.5 the 5 year rule doesn’t apply regarding conversions? Thanks
Permalink Submitted by Alan - IRA critic on Thu, 2015-03-26 21:11
The entire amount rolled over is treated as a conversion, but if the conversion is withdrawn before 5 years, the non taxable portion (180) comes out before the taxable portion. You are correct that if client is 59.5, the 5 year holding period for conversions does not apply at all and there is no 10% penalty.