Question about Traditional IRA

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ifish100
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Question about Traditional IRA

Post by ifish100 » Sun Oct 27, 2019 6:54 pm

I have a pretty simple question about Traditional IRAs. I am nearing 60 years old, wife same age. I plan to retire at 65.
We both have Traditional IRAs at Vanguard.

Mine: $265k, $76.4k of it are non deductible contributions, so this means $188.6k of it is growth and deductible contributions (71% of it). When I was in my very early years there was something like $4k that I took a tax deduction for (wish I had never done that), and this "tainted" this old IRA from just being able to be converted.

Spousal: $140.4k, 68.8k of it are non deductible contributions, this means $71.6 k of it is growth, she never made a deductible contribution (51% of it is growth).

I have considered doing a Roth conversion but I still work, and am in a high tax bracket. We still contribute to these Traditional IRA every year, but just keep bonds in there. We cannot do a direct Roth because the income limit is exceeded and because of tax consequences have not proceeded with converting the entire amount to Roth at once. These "tainted IRA" keep us from doing the backdoor Roth too. If I were not using it to hold of my bond portion of my portfolio I would just stop and put the money into taxable, as there would be less taxes on growth in taxable for capital gains.

My 401k does allow contributions from an IRA into it.

Here is the question. If I just hold on to these until I retire and my income can be managed to be very low, I was thinking about just converting them all to Roth in a single tax year or over a couple of years after retirement and pay little in taxes on them. I plan to live off of my investments, rental income and our pensions until age 70, then start SS. So between 65 and 70 I can regulate my income. My question is.... if I just keep them and take the money from them after retiring, do I owe taxes on just the $188.6k for me and $71.6k for my wife or is the total amount ($265k+$140.4k) taxable?

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grabiner
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Re: Question about Traditional IRA

Post by grabiner » Sun Oct 27, 2019 7:52 pm

When you withdraw from an IRA with non-deductible contributions (whether you convert to a Roth or not), your withdrawal is prorated between deductible and non-deductible amounts. Therefore, 71% of any amount you withdraw will be taxed and 29% will not be taxed, and 51% will be taxed for your spouse.

These taxable ratios will increase if your funds gain value.
Wiki David Grabiner

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ifish100
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Re: Question about Traditional IRA

Post by ifish100 » Sun Oct 27, 2019 9:01 pm

Thank you that makes sense. I thought that would be the case.

Another thought I had was I could transfer my IRA into the 401k at work, that way I would not have that "tainted" Traditional IRA preventing me from just doing a Backdoor Roth each year until 65 (because I would not have an IRA), BUT if I put it over into the 401k, I am not sure if it will still block me from doing the Backdoor Roth. I think I have read somewhere that if you have any other Traditional IRA you cannot do the Backdoor Roth technique, not sure if that also means Traditional IRA parked into a 401k.

My spouse does not work so she would not have a 401k to transfer her IRA into if that idea works anyway.

It may be just easier to wait until 65 and do the conversion (pay the taxes but at a much lower retired rate), I am not sure how complicated putting this "tainted" Traditional IRA into my 401k would later complicate 401k withdrawals.

lakpr
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Re: Question about Traditional IRA

Post by lakpr » Sun Oct 27, 2019 9:18 pm

You can transfer the pretax portion of the IRA into your 401k, so at least you would be able to do backdoor Roth for yourself. It is relatively simple.

1. Make sure you separate the basis and pretax contributions + earnings out into separate funds.
2. Then transfer the fund which includes deductible contributions and pretax earnings on both deductible and non-deductible contributions. 401k plans are not allowed to accept non-deductible contributions (basis) by law.
3. Then convert the remaining basis to Roth and invest according to your asset allocation ratio.

Once the money gets into the 401k, it might be tracked as a separate sub account. But for all intents and purposes, it is 401k money. It would not interfere with the backdoor Roth.

For your wife, since there is no 401k to roll over, invest everything in her account to a bond fund. Compensate by moving bonds to stocks in your own portfolio. This will slow down the growth in that account. When you retire, draw down from this account first and foremost, exhaust it. Should be within 3 to 4 years.

maryannesk
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Re: Question about Traditional IRA

Post by maryannesk » Sun Oct 27, 2019 9:23 pm

David,
I have a question about this too - I started my Traditional IRAs in the mid 80's and now am retiring. Roth IRAs were not available at the time and by the time they were available, I was making too much. Now, I would like to convert my Traditional IRAs to Roths. My IRAs were formed by me mailing after tax money checks to Vanguard. Since I have not contributed to an IRA in about 10 years, they are all noncovered. Why would I have to pay the taxes all over again? Is there a way #1, I can prove that the taxes have been paid and #2, if not, how can I get records from the 80's which show how much I paid for these when the time comes for my RMDs??

I turn 68 in Dec and I would like to convert as much money as possible into Roths but I don't want to be slammed with taxes.

lakpr
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Re: Question about Traditional IRA

Post by lakpr » Sun Oct 27, 2019 9:38 pm

@maryannesk,

The below link provides Form 8606 PDF forms going back to 1987.

https://apps.irs.gov/app/picklist/list/ ... nding=true

If you really have records of which years you made non-deductible contributions to the IRA, you can file form 8606 separately for each year. It is important to start from the first year you made such contribution, since the previous basis gets rolled up to each subsequent year's form.

My understanding is that Form 8606 can be filed independently, since it neither increases nor decreases your tax liability, so no amendment of any past tax return is required.

These forms must be mailed, they cannot be e-filed (e-filing allowed only for current tax year along with tax return)

Any amount in your IRA above the cumulative basis is still tax-deferred, so that amount can be rolled into your workplace 401k, if your plan accepts it. This needs to happen prior to you retiring, of course, unless you work(ed) for Federal Government or GE, and you still have those plan accounts open. Only these plans will accept incoming rollovers from IRA accounts even for ex employees.

Once this is accomplished, the left over basis in the IRA can be converted to Roth, with no further tax due.

It is important to not roll over any funds from 401k to IRA in that calendar year you did that last step of converting non-deductible basis to Roth.

Edited to add: you might want to file the forms 8606 regardless of whether you think you can accomplish the roll over to 401k plan. The IRS needs to know the basis in your IRA, so when you go to withdraw or do Roth conversion, you can figure out the proportion of the conversion that is non-taxable and the proportion that is taxable.

Also edited to add: just because you sent contributions to IRA through checks from your checking account does not mean the contribution is "after-tax" and non-deductible. You might have deducted the contribution from your income on your tax return. Only way to make sure is to pore over the tax returns from those past years line by line. It is a non-enviable task, but just might be worth it for you to not pay double tax if you really did make non-deductible contributions.

maryannesk
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Re: Question about Traditional IRA

Post by maryannesk » Sun Oct 27, 2019 10:13 pm

Lakpr, Thank you so much for this information. I will work on this during the next few weeks. It's overwhelming but I can't see paying twice. When I say I wrote checks, it means that I made payments to my Vanguard accounts after I had deposited my paychecks. I need to take this project on because it will help me not to pay twice as you say. I can't tell you how grateful I am to be given this starting point by you. Thank you.
Maryanne

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grabiner
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Re: Question about Traditional IRA

Post by grabiner » Sun Oct 27, 2019 10:48 pm

maryannesk wrote:
Sun Oct 27, 2019 9:23 pm
I have a question about this too - I started my Traditional IRAs in the mid 80's and now am retiring. Roth IRAs were not available at the time and by the time they were available, I was making too much. Now, I would like to convert my Traditional IRAs to Roths. My IRAs were formed by me mailing after tax money checks to Vanguard. Since I have not contributed to an IRA in about 10 years, they are all noncovered. Why would I have to pay the taxes all over again?
"Non-covered" is an unrelated concept. For covered stocks and mutual funds (bought since 2012), your brokerage is required to keep track of the cost basis, and report the capital gain or loss to the IRS when you sell. This does not apply to an IRA, because your brokerage cannot have a record of whether your contribution was deductible or not; this depends on your income and filing status, which the brokerage does not know.

Thus, when you withdraw from your IRA, your 1099 will have a box checked, "Taxable amount not determined", which means that it is up to you to determine this amount. Lakpr already documented how to do this.
Wiki David Grabiner

lakpr
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Re: Question about Traditional IRA

Post by lakpr » Sun Oct 27, 2019 10:57 pm

maryannesk wrote:
Sun Oct 27, 2019 10:13 pm
When I say I wrote checks, it means that I made payments to my Vanguard accounts after I had deposited my paychecks.
You are welcome, Maryanne.

But I want to belabor this point again. What you wrote above is how everyone contributes to their IRA. The more relevant question is, were you able to deduct this amount from your income, and arrive at an Adjusted Gross Income figure that is less than Wages and other income by exactly the amount you wrote the check for?

I just took a peek at old 1040 forms (1997 and 1999 samples) on the IRS site. If the amount you wrote checks to deposit in Vanguard account is the same as Line 23 on those old 1040 forms (labeled "IRA deduction"), then you got tax deduction during that year for that contribution. You need to do this scrutiny for every year, before determining the basis. If this field is 0, then you did not receive tax deduction in that year, and therefore can be legitimately called as a "non-deductible contribution" that you should not be paying tax for a second time.

Best of luck, and I really hope that you are able to successfully determine the basis in your IRA account.
Last edited by lakpr on Mon Oct 28, 2019 5:13 am, edited 1 time in total.

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FiveK
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Re: Question about Traditional IRA

Post by FiveK » Sun Oct 27, 2019 11:28 pm

maryannesk wrote:
Sun Oct 27, 2019 9:23 pm
Is there a way #1, I can prove that the taxes have been paid and #2, if not, how can I get records from the 80's which show how much I paid for these when the time comes for my RMDs??
Do you have all the tax returns covering the years you made IRA contributions? If so, look in the bottom section of the first page of Form 1040. E.g., in 1989 (https://www.irs.gov/pub/irs-prior/f1040--1989.pdf) it would have been line 24 and/or 25, and in 2005 (https://www.irs.gov/pub/irs-prior/f1040--2005.pdf) it would have been line 32.

If you did not deduct your IRA contribution in a given year, then previous comments about Form 8606 apply. If you did deduct your IRA contribution in a given year, then you will owe tax on that contribution when withdrawn. In any case, you will owe ordinary income tax on all the gains in the tIRA account when withdrawn.

ETA: I see lakpr posted pretty much the same thing - at least you are getting consistent feedback....

cas
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Re: Question about Traditional IRA

Post by cas » Mon Oct 28, 2019 5:44 am

grabiner wrote:
Sun Oct 27, 2019 7:52 pm
When you withdraw from an IRA with non-deductible contributions (whether you convert to a Roth or not), your withdrawal is prorated between deductible and non-deductible amounts. Therefore, 71% of any amount you withdraw will be taxed and 29% will not be taxed, and 51% will be taxed for your spouse.
OP: Note that the pro-rating occurs ONLY if you tell the IRS about each of your non-deductible contributions using Form 8606.

Did you file an IRS Form 8606 for every year that a non-deductible contribution was made for you and/or your wife? (Separate Form 8606 for you and your wife).

(The fact that your detailed post doesn't ever mention Form 8606 is making me nervous. Not filing Form 8606 is a very common mistake that I see on this forum regarding non-deductible IRA contributions.)

If you did not file form Forms 8606, then the IRS knows nothing about your non-deductible contributions, and you will end up paying tax on the total amount (currently $265k + $140.4k). (The IRS allows you to fix this problem by filing the missing Forms 8606 with them now.)

KingRiggs
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Re: Question about Traditional IRA

Post by KingRiggs » Mon Oct 28, 2019 10:51 am

lakpr wrote:
Sun Oct 27, 2019 9:38 pm
@maryannesk,

The below link provides Form 8606 PDF forms going back to 1987.

https://apps.irs.gov/app/picklist/list/ ... nding=true

If you really have records of which years you made non-deductible contributions to the IRA, you can file form 8606 separately for each year. It is important to start from the first year you made such contribution, since the previous basis gets rolled up to each subsequent year's form.

My understanding is that Form 8606 can be filed independently, since it neither increases nor decreases your tax liability, so no amendment of any past tax return is required.

These forms must be mailed, they cannot be e-filed (e-filing allowed only for current tax year along with tax return)

Any amount in your IRA above the cumulative basis is still tax-deferred, so that amount can be rolled into your workplace 401k, if your plan accepts it. This needs to happen prior to you retiring, of course, unless you work(ed) for Federal Government or GE, and you still have those plan accounts open. Only these plans will accept incoming rollovers from IRA accounts even for ex employees.

Once this is accomplished, the left over basis in the IRA can be converted to Roth, with no further tax due.

It is important to not roll over any funds from 401k to IRA in that calendar year you did that last step of converting non-deductible basis to Roth.

Edited to add: you might want to file the forms 8606 regardless of whether you think you can accomplish the roll over to 401k plan. The IRS needs to know the basis in your IRA, so when you go to withdraw or do Roth conversion, you can figure out the proportion of the conversion that is non-taxable and the proportion that is taxable.

Also edited to add: just because you sent contributions to IRA through checks from your checking account does not mean the contribution is "after-tax" and non-deductible. You might have deducted the contribution from your income on your tax return. Only way to make sure is to pore over the tax returns from those past years line by line. It is a non-enviable task, but just might be worth it for you to not pay double tax if you really did make non-deductible contributions.
I'm terribly sorry to piggy-back off this thread, but it's very close to a question I have.

Before we were married, my DW's father opened an IRA for her. I believe he wrote the contribution checks and created the account in her name. We do not have returns dating back that far (about 1988-89), and the brokerage it was started with is defunct, so I can't PROVE that she did or didn't take a deduction. Total contributed was about $2,000 per FIL's recollection. After those first year or two of father-funded contributions, she stopped adding to the account. Fast-forward to today and the account is worth about $20,000.

She is a SAHM with no income. I would love to get this account moved so that I could make spousal backdoor Roth contributions for her, as we are over the MFJ limit to deduct. I would assume her options would be:

1) Convert the entire amount to Roth, paying the tax bite (which would be 37% + NIT, so about $8,000)
2) Let it sit and grow, then do Roth conversions in the years between retirement and claiming SS.
3) Get/create a job so she could contribute to/open an employer 401k/solo 401k which would allow her to roll the IRA into it.

I would love to get access to additional Roth space to improve tax diversification in retirement. Are there any other options I'm missing?
Advice = noun | Advise = verb | | Roth, not ROTH

lakpr
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Re: Question about Traditional IRA

Post by lakpr » Mon Oct 28, 2019 11:39 am

@KingRiggs,
I think you have outlined all the options pretty much ... can't think of anything else.

The $2000 does seem to indicate that this is a pre-tax IRA and not a non-deductible one, as $2000 was the limit back then for IRA contributions.

One idea I might propose is, if your wife has the time and inclination, is to become a substitute teacher in the local school district. You can claim that to be your "business", and open a Solo 401k for the income earned, roll this IRA into the Solo 401k. As long as she has a bachelors degree, I think substituting for teachers should be fine. Here in NJ, you'd have to register with the school district to be alerted for substitute opportunities, and the first one to respond gets it. [ There is a background check you must pass, though, since you are coming in contact with children ]

My wife is now a full-time teacher, but it has been my experience that she got calls almost daily.

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cruzbay
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Re: Question about Traditional IRA

Post by cruzbay » Mon Oct 28, 2019 2:10 pm

lakpr wrote:
Sun Oct 27, 2019 9:18 pm
You can transfer the pretax portion of the IRA into your 401k, so at least you would be able to do backdoor Roth for yourself. It is relatively simple.

1. Make sure you separate the basis and pretax contributions + earnings out into separate funds.
2. Then transfer the fund which includes deductible contributions and pretax earnings on both deductible and non-deductible contributions. 401k plans are not allowed to accept non-deductible contributions (basis) by law.

3. Then convert the remaining basis to Roth and invest according to your asset allocation ratio.

Once the money gets into the 401k, it might be tracked as a separate sub account. But for all intents and purposes, it is 401k money. It would not interfere with the backdoor Roth.



How do I accomplish #1, the separating of basis and pre-tax monies into separate funds? I want to send the pre-tax (earnings) to the TSP/401K and convert the non-deductible basis to Roth all in one chunk. The people at Schwab seemed reluctant to do this. I have 8606 forms filed to document basis. Thanks!

lakpr
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Re: Question about Traditional IRA

Post by lakpr » Mon Oct 28, 2019 2:21 pm

cruzbay wrote:
Mon Oct 28, 2019 2:10 pm
lakpr wrote:
Sun Oct 27, 2019 9:18 pm
You can transfer the pretax portion of the IRA into your 401k, so at least you would be able to do backdoor Roth for yourself. It is relatively simple.

1. Make sure you separate the basis and pretax contributions + earnings out into separate funds.
2. Then transfer the fund which includes deductible contributions and pretax earnings on both deductible and non-deductible contributions. 401k plans are not allowed to accept non-deductible contributions (basis) by law.

3. Then convert the remaining basis to Roth and invest according to your asset allocation ratio.

Once the money gets into the 401k, it might be tracked as a separate sub account. But for all intents and purposes, it is 401k money. It would not interfere with the backdoor Roth.

How do I accomplish #1, the separating of basis and pre-tax monies into separate funds? I want to send the pre-tax (earnings) to the TSP/401K and convert the non-deductible basis to Roth all in one chunk. The people at Schwab seemed reluctant to do this. I have 8606 forms filed to document basis. Thanks!
I am not sure if you can do it all in one chunk/one step.

This is how I am envisioning it would play out: You have $10k in the tIRA, with $4k as non-deductible basis. Currently, all $10k is in Total Stock Market fund (say). What you should do is to sell $4k from Total Stock Market Fund, and buy an almost-equivalent fund, let's say the Large Cap Index fund (say).

Then initiate a transfer into your 401k from only the Total Stock Market Fund. You know that this remainder $6k is completely either pre-tax contributions + earnings on both the pre-tax contributions and non-deductible contributions. The earnings themselves are also pre-tax.

You will be able to, in good conscience, let your 401k plan know that you are rolling in only pre-tax amounts from your traditional IRA.

Once the money settles in 401k, go back to the IRA account, convert and sell Large Cap Index fund into Roth IRA Total Stock Market Index fund. Pay tax on any tiny fluctuations in value that may have occurred in the mean time.

I think it is possible to rollover only from ONE specific fund into 401k, it's not necessary to roll everything in the IRA over.

Where would you find out how much to separate out into a new fund? From your Form 8606

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cruzbay
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Re: Question about Traditional IRA

Post by cruzbay » Mon Oct 28, 2019 2:36 pm

Thanks lakpr for your response. The money is sitting in cash awaiting a transfer. The TSP has their own "funds" that aren't the usual ones for total stock, etc. I think that I would have to transfer cash to the TSP (and then allocate to one of their funds) and then convert the basis to Roth, leaving a zero balance in the tIRA on Dec 31st. I understand that I would need to pay tax on any gains on the basis after transferring the pre-tax (earnings) cash to the TSP. Immediately upon arrival at the Roth, it will go into Total Stock Market.

lakpr
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Re: Question about Traditional IRA

Post by lakpr » Mon Oct 28, 2019 4:07 pm

cruzbay wrote:
Mon Oct 28, 2019 2:36 pm
Thanks lakpr for your response. The money is sitting in cash awaiting a transfer. The TSP has their own "funds" that aren't the usual ones for total stock, etc. I think that I would have to transfer cash to the TSP (and then allocate to one of their funds) and then convert the basis to Roth, leaving a zero balance in the tIRA on Dec 31st. I understand that I would need to pay tax on any gains on the basis after transferring the pre-tax (earnings) cash to the TSP. Immediately upon arrival at the Roth, it will go into Total Stock Market.
If I read you correctly, you are having is that Schwab is refusing to transfer only PART of the cash that you have parked in the money market fund. You may have to move the "basis" amount from that cash/money-market-fund and invest it in the market, but don't convert it yet.

If the cash is all pre-tax earnings and deductible contributions with 0 basis, then Schwab giving you a hard time is only because they are reluctant to lose you as a customer (I am speculating)

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cruzbay
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Re: Question about Traditional IRA

Post by cruzbay » Mon Oct 28, 2019 4:22 pm

I will investigate this. Sounds like a solid approach. Thanks so much!

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