Non-Deductible IRA Roth Conversion Question
Good Morning!
I have a client that has an IRA value (currently in cash) of $764,968.49. Of that account value, it contains $13,074.97 of after tax contributions, which make up roughly 1.7% of the account. We are looking to begin converting this balance over to Roth, but want to make sure we are approaching the process the right way. Can we take care of the non-deductible balance in one felt swoop, or do we need to use the pro-rate rule for each specific conversion?
Thanks in advance for your help!
Sincerely,
Jeff
Permalink Submitted by Alan - IRA critic on Fri, 2019-05-17 15:53
The pro rata rule and Form 8606 applies, so any conversion would be 98.3% taxable. The only way to avoid this is to roll all but the 13,075 to an accepting employer plan and then convert the 13,075 tax free. That will eliminate the IRA basis with one non taxable conversion. In the following year, the pre tax amount that was rolled over to the employer plan might be able to be rolled back into the IRA if the employer plan permits this, and most do. Client will then have a fully pre tax IRA with no basis.
Permalink Submitted by Jeffrey Truchon on Fri, 2019-05-17 16:29
Thank you Alan! I thought that was the case. To confirm, is the percentage of assets based on the previous year-end balance? IE, divide the non-deductible contribution amount by the account value on 12/31/18? Lastly, what is the most effecient way to report which portion of the conversion is taxable vs which is not when filing taxes the following year? Thanks for your help!
Permalink Submitted by Alan - IRA critic on Fri, 2019-05-17 18:06
Form 8606 calculates the taxable and non taxable amounts of any conversion. Part II summarizes this breakdown and those numbers then feed over to lines 4a and 4b of Form 1040. The taxable portion calculation is based on the current year end value of all non Roth IRA accounts, not the prior year end. All distributions in the current year are also included in the calculation if you took other distributions during the current year.
Permalink Submitted by Jeffrey Truchon on Fri, 2019-05-17 19:28
Hi Alan, thanks for the follow up. Lastly, to clarify, if we convert $100,000 today, the percentage of how much will be considered taxable is based on the account value ending 12/31/19. So for instance if the account drops to $500,000 (negative market activity plus the $100,000 conversion amount) as of year end, then the notaxable amount of $13,075 would be worth 2.1% of the overall account value…therefore, any coversions done throughout this calendar year would be 97.8% taxable?
Permalink Submitted by Alan - IRA critic on Fri, 2019-05-17 20:05
You are correct. Losses from here to year end will increase the non taxable portion of your conversion and gains will reduce it.