Pre-1987 post tax IRA distribution

Submitted by james olson on Wed, 2018-07-25 19:21

I turned 70 1/2 this year so will need to do an RMD this year (or by April 2019) . I Have several roll-over IRAs and one traditional IRA. In 2005, I rolled a 401(k) into two new IRAs, one of which consisted only of about $40,000 of after tax contributions, $25,000 of which was pre-1987 and $15,000 post-1986. I haven’t commingled any other funds in this IRA but over time it has increased in value to $120,000. I understand that for most after tax monies I will be required to take the after tax amounts out as a pro rata share of my overall IRA balances.
My question, though, is whether I can take the $25,000 which is pre-1987 and roll it into a Roth without being subject to the pro-rata requirement? I gather I could do such if I were today making a 401k) to roll-over IRA conversion but my conversion was in 2005 before the IRS seems to have dealt with this issue.



Submitted by Alan - IRA critic on Wed, 2018-07-25 19:50

Once these funds were rolled into a TIRA, they lose their identity as grandfathered pre 87 AT contributions to be separated from the rest of the IRA balance. Therefore, distributions from the TIRA are all subject to the pro rate rules reported on Form 8606. This has always been the case for IRA distributions.  However, you did acquire additional basis in your TIRA accounts and should file Form 8606 to report the additional basis on line 2.  You will need to file the 8606 for all distributions including RMDs to recover your total IRA basis and therefore a portion of your distributions will be non taxable. You could have made direct rollovers from the 401k to your Roth IRA starting in 2008 and 100k income limits were lifted in 2010.  So there was no way to avoid TIRA commingling of basis prior to 2008.

Submitted by james olson on Thu, 2018-07-26 15:20

I was afraid of this although it seems somewhat unfair that a method is now allowed which wasn’t in 2005 and the result is I don’t get any benefit from the pre-1987 money (beyond the pro rata share).

Submitted by Alan - IRA critic on Thu, 2018-07-26 17:26

If you have enough basis in your TIRA, it might make doing incremental Roth conversions viable since only a portion will be taxed. That said, you must complete your RMD before doing any conversion, and while the RMD and conversion will have the same % as taxable, it would likely have been better to convert before RMDs started as your taxable income would have been lower then.

Submitted by james olson on Mon, 2018-07-30 21:01

Alan,Thank you for the explanation. I am not sure I completely understand the mechanics of the RMD.  I have several   IRAs  (three roll-over, one traditional and a Roth held  with two mutual fund companies, as well as a TSP account) and will have to withdraw about $100,000 initially.  The after-tax total is about $60,000 or 3% of the total.   I assume I can  take the $100,000 from any of the non-Roth IRAs. Correct?  I would like to put the 3% in the Roth.  So, can I take $3,000 once I receive the RMD and put it in the Roth or do I need to have a direct distribution  of that amount to the Roth? Thanks for your thoughts. 

Submitted by Alan - IRA critic on Mon, 2018-07-30 23:27

  • If no longer working for the govt, you must take a TSP RMD separate from the IRA RMDs, but for the IRA RMDs, you can take the distribution in any combination from the 3 non Roth IRAs.  3% of the IRA RMD will be non taxable due to the pro rata rules.
  • You did not mention the TSP before, but because the TSP will take IRA rollovers even after you retire, you have the opportunity to re do what you could not do in 2005, but it will take some work. Here is how this could be executed if you wish. First, take your IRA RMD in total, and around 97% will be taxable. Next roll over your entire IRA balance except for your IRA basis into the TSP. When that is completed you can convert the remaining IRA basis to your Roth IRA tax free.  Starting in 2019 you can roll the pre tax IRA amount or the entire TSP if you wish into your IRA, and from that point on your IRA will be 100% pre tax money and you will avoid any future pro rating. Your IRA RMDs will then be 100% taxable.
  • Note that this must be done this year, but will not help you until next year because you have to take your IRA RMD out with pro rating before you can do the rollover to the TSP. Then in 2019, you will have to complete the TSP RMD before rolling the rest back to the IRA if you want to. Because your RMDs have started, you must complete the RMDs before doing any other rollovers or conversions.
  • This procedure is the only way you can convert to a Roth without pro rating. If you do not do the rollover to the TSP, then any conversion you do to the Roth (after the RMD) will be pro rated between IRA basis and pre tax amounts, so moving that 3% of after tax money to the Roth IRA is not possible. But if you do the rollover to the TSP, then you can convert your entire IRA basis left behind in the IRA to your Roth IRA.

Submitted by Bruce Steiner on Sun, 2018-08-05 01:29

A retired Federal employee who earns a tiny amount from a new job has a TSP account, and a small traditional IRA with no basis.  Does this mean she can transfer her traditional IRA into her TSP account, and then make nondeductible IRA contributions of her earnings from her new job (or from her spouse’s earnings, up to $6,500 a year) and do backdoor Roth conversions of these contributions?  Can she make these IRA contributions out of her spouse’s earnings even if he doesn’t make any IRA contributions of his own?

Submitted by james olson on Tue, 2018-07-31 19:03

Very interesting idea. If I understand it, I can put all of the post-tax money, both the pre-87 $24,000 and post-86 $36,000 for a total of $60,000 into a Roth if I follow the steps you enumerated.  A couple of mechanical questions:  (1) Does it matter which of the roll-over IRAs I leave the $60,000 in when I shift the bulk to the TSP? Right now it is isolated in one of the roll-over IRAs but it would work better for me to leave it in another of the roll-over IRAs which is with a mutual fund company where I now have my Roth. (2) When I start the process it may take a couple of weeks for all of the $$ to be transferred to and be received by the TSP.  If I have left $60,000 in one of the IRAs it may earn $50 or so  in the transitional period (assuming it’s in a money market fund) before the larger transfers are completed. How do I account for that? Could I just designate that $60,000 as a new Roth effective as of the date I transfer the rest of the money out?(3) For calculating the  the post-tax pro rata share, do I include the TSP blance or is it completely off to the side?Thanks again for your thoughts.  

Submitted by Alan - IRA critic on Sun, 2018-08-05 02:55

  • Re bsteiner questions, yes to all of them as long as retired employee is not yet 70.5. TSP is one of the few plans that will accept IRA rollovers for former employees, and a spousal contribution can be made using working spouse’s income even when the working spouse has reached 70.5.
  • Re jwolson’s questions – 1) It does not matter which IRA is used to fund the TSP rollover. A special rule states that the first dollars from any non Roth IRAs rolled to a qualified plan is deemed to constitute pre tax IRA amounts until exhausted. In other words, 60k must be left in any combination of the non Roth IRAs.  2)  Do not worry about a small amount of earnings on the 60k, just convert the total IRA balance and pay taxes on the small amount of earnings. What must be avoided is rolling any IRA basis into the TSP and leaving less than 60k in the IRA.   3) The TSP balance is ignored when determining the taxable amount of the IRA conversion. The TSP balance is not included on Form 8606 when reporting the taxable amount of the conversion.

Submitted by james olson on Mon, 2018-10-01 16:39

Alan, Thanks for your very helpful thoughts about transferring pre-tax IRA  $$ to TSP to isolate the post-tax IRA portion and allow its conversion to a Roth. I have taken my 2018 RMD from the IRAs and am now ready to do the transfers and ask for the RMD from the TSP.  However, I just read an article by a CPA that says those who are 70.5 or older (I’m 71) who are receiving RMDs cannot transfer $$ to a TSP account. I read the relevant TSP pubs and saw no such language and called the TSP and was told there was no such restriction.  Is it correct that there is no such restriction?  Also, as I proceed with this plan, now that I have withdrawn the RMD for 2018 from the IRAs, does the order of the remaining steps (withdrawing the TSP RMD and transferring the IRAs into the TSP) make any difference? Thaks again.

Submitted by Alan - IRA critic on Tue, 2018-10-02 02:56

  • I agree that there is no restriction for TSP rollovers for those subject to IRA RMDs, although the TSP transfer form does make it clear that the TSP cannot accept RMD distributions. Since the first distribution from any of your IRAs is deemed to apply to the collective IRA RMD, you must complete the IRA RMD before rolling the remaining pre tax IRA balance (of all your non Roth IRAs) to the TSP.
  • You have now withdrawn your RMD (I assume total RMDs for all your non Roth IRAs). Next you should complete the TSP rollover of your IRA pre tax balance, but here is where this gets very tricky. The breakdown I posted earlier is not correct because of the way Form 8606 is designed. The taxable amount of your RMD distribution is not determined until the end of the year because it is based on your year end IRA balance and that will be 0 due to the TSP rollover. Since your IRA basis is 60k and your RMD distribution is more than that, you will receive all of your 60k of basis in your RMD and that will not leave anything to convert. If you want to verify this on a Form 8606, you would have 60k on line 5, 0 on line 6, 100k (your total RMD plus other distributions on line 7, 100k on line 9, .600 on line 10, 60k on line 12 and 13 (non taxable amount of your RMD) and 0 on line 14. Line 15a will show 40,000 as the taxable amount of your RMD. In other words, all your basis is used up with your RMD leaving no basis to convert. 
  • Therefore, you will roll the entire balance of all your non Roth IRAs to the TSP after taking the RMD. Once you roll the TSP back to an IRA next year, your IRA will be 100% pre tax since your 60k of basis was recovered as part of your 2018 RMD. You will not have to deal with Form 8606 again unless you later convert pre tax money to your Roth IRA and those conversions would be 100% taxable.
  • This is a rare combination of circumstances, and quite complex so you will probably have further questions.

Submitted by james olson on Tue, 2018-10-02 20:05

Yes, definitely questions.   The purpose of the transfer of the pre-tax IRA balances to the TSP was to allow for the post-tax money to be isolated and put into a Roth.  If as you say the 8606 language means that the RMD will be assumed to contain the  60k of post-tax money does that mean that I cannot put that 60k into a Roth?  If so, there is no reason to transfer the IRA funds to the TSP and  I will just  take the small percent of after-tax money from each year’s RMD.

Submitted by Alan - IRA critic on Tue, 2018-10-02 23:04

  • This would have worked OK if completed prior to your first RMD year because there would not have been any IRA distributions. But the taxes on the RMD can still be vastly reduced by rolling pre tax dollars to the TSP. If you don’t do that you already know that about 97% of your RMD will be taxable. If you do roll the IRA to the TSP after the RMD, then only about 40% (40k) will be taxable, and you will also have the advantage of not having to deal with a small % of IRA basis every year in the future.
  • If you still want to get 60k into your Roth IRA, you can use the tax savings on 57k of your IRA to pay the taxes on a conversion to Roth next year after you roll the TSP back out. In other words, you can utilize that IRA basis right away using either approach, but they both involve a rollover to the TSP.  Those who are not TSP participants are stuck with pro rating IRA basis for the rest of their lives, so you should take advantage of the chance to roll your pre tax IRA dollars (that would be your entire TIRA balance after this year’s RMD) into the TSP and eliminate having to deal with pro rated tax issues every year after this year.

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