[Traditional to Roth IRA conversion - backdoor?]

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zoecat
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[Traditional to Roth IRA conversion - backdoor?]

Post by zoecat »

[Moved into a stand-alone thread from: Need help to understand tIRA rIRA conversion --admin LadyGeek]

I have another backdoor Roth question for which I cant seem to find the answer. My wife and I both have taxable IRAs which are currently in a loss position - meaning the amount of after tax cash we contributed to the tIRA is greater than its current value (what can happen by investing in individual stocks, but I'm a boglehead now).

I want to now convert the tIRAs to Roths. My wife currently has 401Ks at two former employers which she has never rolled into a rollover IRA. I know that if I rollover my wife's 401K assets from the former employers into (non-taxable) IRAs, and then convert her taxable IRA to a Roth, we would get hit with income tax based on the proportion of taxable and non-taxable IRA assets.

So, as noted above by another poster, it is often best to not convert a former employer 401K to a rollover non-taxable IRA b/c it can create taxes when converting the taxable IRA to the Roth. My question is whether the losses in my wife's tIRA would shelter any of the income that would otherwise result if I rolled over her former employer 401K to a rollover non taxable IRA. So say she has 10K in the 401K that roll to the non-taxable IRA. And say she has $10K in the taxable IRA w/ a basis of $20K. Could she convert both IRAs to a Roth and not pay any taxes (10K in income from rollover IRA being offset by $10K in loss in tIRA) or would she have to pay taxes on the 10K from the 401K rollover and the loss in the tIRA converting to Roth goes away? Thanks.
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retiredjg
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Re: Need help to understand tIRA rIRA conversion

Post by retiredjg »

zoecat wrote: Thu Nov 16, 2017 4:32 am I have another backdoor Roth question for which I cant seem to find the answer. My wife and I both have taxable IRAs which are currently in a loss position - meaning the amount of after tax cash we contributed to the tIRA is greater than its current value (what can happen by investing in individual stocks, but I'm a boglehead now).

I want to now convert the tIRAs to Roths. My wife currently has 401Ks at two former employers which she has never rolled into a rollover IRA. I know that if I rollover my wife's 401K assets from the former employers into (non-taxable) IRAs, and then convert her taxable IRA to a Roth, we would get hit with income tax based on the proportion of taxable and non-taxable IRA assets.

So, as noted above by another poster, it is often best to not convert a former employer 401K to a rollover non-taxable IRA b/c it can create taxes when converting the taxable IRA to the Roth. My question is whether the losses in my wife's tIRA would shelter any of the income that would otherwise result if I rolled over her former employer 401K to a rollover non taxable IRA. So say she has 10K in the 401K that roll to the non-taxable IRA. And say she has $10K in the taxable IRA w/ a basis of $20K. Could she convert both IRAs to a Roth and not pay any taxes (10K in income from rollover IRA being offset by $10K in loss in tIRA) or would she have to pay taxes on the 10K from the 401K rollover and the loss in the tIRA converting to Roth goes away? Thanks.
Welcome to the forum. :happy

What do you mean by "non-taxable IRA"? There really is no such thing so it's hard to understand what you are asking.
FactualFran
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Re: [Traditional to Roth IRA conversion - backdoor?]

Post by FactualFran »

If the total balance of an individual's traditional, SEP, and SIMPLE IRAs is $X and the total basis (non-deducted contributions) of those IRAs is $X, then income tax would not be owed on a conversion done from those IRAs to a Roth IRA. If the total basis was half of the balance, then income tax would be owed on 50% of the conversion amount.
Topic Author
zoecat
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Re: [Traditional to Roth IRA conversion - backdoor?]

Post by zoecat »

Retiredjg - By non-taxable IRA, I mean an IRA which is the result of a rollover from a 401K. The money in the IRA has never been taxed.

FractualFran - I probably wasn't clear enough.

Changing the facts a bit to simplify things. I have two IRAs:

1. A rollover IRA (assets came from a 401K and have never been taxed) with a value of $10,000.
2. A taxable IRA (after tax money was contributed to the IRA to purchase assets) with a current value of $10,000, but my basis in $20,000. Assume I contributed over time $20K to the tIRA, and it has lost 50% of its value.

If I convert both IRAs to Roth, do I have to pay tax on the $10,000 in the rollover IRA (since it has never been taxed) or can I offset that amount with the $10,000 loss in the tIRA?

Thanks.
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retiredjg
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Re: [Traditional to Roth IRA conversion - backdoor?]

Post by retiredjg »

If she converts $20k in IRA to Roth IRA, she will not pay tax because there is a "basis" (already taxed money) of $20k. This assumes that the basis was documented on Form 8606 when the non-deductible contributions were made. If the Form was not done, that can be fixed but it must be fixed before doing the Roth conversion.

Your situation is a little different. If you convert your IRA to Roth, you will not pay tax either, but there is a disagreement about whether you loose the extra basis or whether it carries over for future use. To avoid this, you might want to wait until there is more money in that IRA before doing the Roth conversion.


While working through this, things will just get confused if you continue to use the terms "taxable IRA" and "non-taxable IRA" since there are no such things and the terms are easy to misinterpret. Here's some information that might help.

An IRA can contain deductible contributions (pre-tax money) or non-deductible contributions (already taxed money or "basis") or a combination of the two.

A "rollover IRA" is assumed (unless otherwise mentioned) to contain only pre-tax money - like from a 401k. When just talking about an "IRA", you have to state if the contributions were pre or post tax (or deductible or non-deductible) or a combination.


When considering a Roth conversion, you have to consider ALL the money in ALL of a person's IRAs except Roth IRA or inherited IRA in someone else's name. This includes rollover IRA, traditional IRA, SEP IRA and SIMPLE IRA - so be careful that no other IRAs like this exist.
Topic Author
zoecat
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Re: [Traditional to Roth IRA conversion - backdoor?]

Post by zoecat »

Thanks. So to state it correctly -

She has an IRA currently comprised of $10K of pre-tax money (from a 401K rollover) and $10K of non-deductible contributions. She has a basis in the $10K of non-deductible contributions of $20K. (I'm having my accountant refile the 8606s from the first contribution on - which was about seven years ago (so seven years of 8606s) - I think they were filed but I'm not 100% certain).

When she rolls over the IRA to a Roth, she will not have to pay tax on the $10K of pre-tax money (from the 401K rollover) b/c she is rolling over $20K and she has $20K in basis. Do I have that correct?

Regarding "loosing the extra basis or whether it carries over for future use", I'm confused. If the money is in a Roth, then all of it comes out tax free. So basis there doesn't really matter. Unless you are saying that if she has $0 in the IRA from pre-tax money and $10K of non deductible contributions with a basis of $20K, and she rolls over the IRA to a Roth, then the question becomes whether, if in the future she were to roll over a pre-tax IRA to a Roth, does she get to use the $10K loss to offset taxes that would otherwise apply upon that future roll over.
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retiredjg
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Re: [Traditional to Roth IRA conversion - backdoor?]

Post by retiredjg »

zoecat wrote: Tue Nov 21, 2017 7:47 am Thanks. So to state it correctly -

She has an IRA currently comprised of $10K of pre-tax money (from a 401K rollover) and $10K of non-deductible contributions. She has a basis in the $10K of non-deductible contributions of $20K. (I'm having my accountant refile the 8606s from the first contribution on - which was about seven years ago (so seven years of 8606s) - I think they were filed but I'm not 100% certain).

When she rolls over the IRA to a Roth, she will not have to pay tax on the $10K of pre-tax money (from the 401K rollover) b/c she is rolling over $20K and she has $20K in basis. Do I have that correct?
Yes that is how your situation appears to me.
Regarding "loosing the extra basis or whether it carries over for future use", I'm confused. If the money is in a Roth, then all of it comes out tax free. So basis there doesn't really matter. Unless you are saying that if she has $0 in the IRA from pre-tax money and $10K of non deductible contributions with a basis of $20K, and she rolls over the IRA to a Roth, then the question becomes whether, if in the future she were to roll over a pre-tax IRA to a Roth, does she get to use the $10K loss to offset taxes that would otherwise apply upon that future roll over.
When I mentioned "losing basis", I was talking about you and your IRA with basis which is at a loss.

Let's say you contributed $12k and it is now worth $7k. You can convert that to Roth with no tax, but what happens to the other $5k in basis? Some people say you can't have basis in something that no longer exists. Some say you get to keep the $5k in basis on your Form 8606 and use it in the future (I fall into this camp). I think (not sure) we've heard that software can come up with both answers (obviously not at the same time).
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