Non-deductible IRA to Roth conversion and when tax free

Submitted by alberto vega on Thu, 2018-11-01 00:20

Married individual 71 years old in May 2018. Took already the 2018 RMD in Sept 2018. Has a non-deductible IRA.
Wants to convert to a Roth IRA on Nov 1, 2018. No state income tax
Balance in IRA as of 11/1/2018 is $12,000 non-deductible contributions and $5,000 income =$17,000 total.
If $1,000 in earnings now, 2018 balance as of 12/31/18 will be $ 18,000.
If earnings are $ 1,000 each in years 2019, 2020, 2021, 2022, IRA total will be $22,000 on 12/31/2022.
Is taxation as follows:

1. Will have to pay tax now on $5,000 (interest) portion of converted balance as of 11/1/18. $ 12,000 is tax free because they were non-deductible contributions and additional $ 1,000 is also tax free because it was earned after the Roth conversion in 2018
2. Earnings of $1,000 after 11/1/2018 in each subsequent years 2019-2022 will be tax free. Results a total balance of $ 22,000 as of 12/31/ 2022.
3. Takes out entire Roth balance of $22,000 on January 1, 2023. Had Roth for 5 years, therefore entire amount is now tax free ?
4. Of course he paid taxes on the $5,000 interest in the traditional non-deductible IRA when converted



Submitted by Alan - IRA critic on Thu, 2018-11-01 01:10

  1. If the individual took the RMD earlier, and then converts the entire remaining balance of ALL their non Roth IRAs on 11/1, the taxable amount for the year will be the total distributed less the basis of 12,000. Then any future gains will all come in the Roth IRA because there will no longer be a TIRA after 11/1.
  2. Roth earnings do not become tax free until 5 years has passed from the date of the first Roth contribution. 
  3. Yes, if the 5 years is completed by 12/31/2022, the entire Roth balance can be distributed tax free in 2023 or later.
  4. Yes. And since TIRA was fully converted this year, there is no longer a TIRA balance and there are no longer any RMDs. All this assumes that there was only 1 TIRA with no other ones left, just the Roth.

Submitted by alberto vega on Thu, 2018-11-01 02:51

If same individual  had other traditional IRA’s of course  would have to take additional RMD

Submitted by Alan - IRA critic on Thu, 2018-11-01 03:55

Yes, and more of the conversion and the RMD would be taxable than if this was the only TIRA. The reason for that is because IRA basis of 12,000 is not assigned to any particular IRA account, it applies over all TIRA accounts. Therefore, only part of the 12,000 basis could be applied to these distributions.

Submitted by alberto vega on Thu, 2018-11-01 16:15

So at conversion you indicate the  taxable ratio would not be  5000/17000. But Because  this individual had more traditional IRA’s with also non-deductible contributions wouldn’t that help tominimize the tax.? For example if he had others  traditional IRA  with $100,000 in non-deductible contributions and $200,00 in market value. 

Submitted by Alan - IRA critic on Thu, 2018-11-01 17:03

  • No. Basis does not apply per account, it applies spread over all non Roth IRA accounts. In your most recent question the total basis is 112,000 and that figure should be shown on line 14 of the last 8606 filed.  The RMD and the conversion are taxed at the same ratio, so in your last question the taxable ratio would be 105,000/217,000 or 48.4%, which is higher than the 29.4% if the only IRA owned was the 17,000 IRA with 12,000 of basis.  
  • You could work some examples with a copy of Form 8606. The total basis amount to start goes on line 2.
  • Also, the RMD for the particular account being converted must be completed first, but not for other IRA accounts which can be distributed after the conversion. This rule can be confusing.

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