Roth Conversion Pro Rata Math

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Topic Author
jeffreys
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Joined: Wed Jan 24, 2018 7:46 pm

Roth Conversion Pro Rata Math

Post by jeffreys »

Part One:

I want to do a Roth coversion with some of my traditional IRA funds. Let's say I convert $10,000, I understand that I will be adding $10,000 to my income for 2019 as I will now owe taxes on that money. Straight forward.

However, I am faced with the pro-rata rule due to a non-deductible IRA contribution.

Let's say I have a total of $100,000 and $5,500 of that was a non-deductible contribution. Doing the math of $5,500/$100,000 gives me .055 which is the percentage of my post-tax contributions. Multiple the $10,000 conversion by .055 gives me $550. As I understand that $550 is not taxable so I will now only add $9,450 to my income. Am I right so far?

Looking ahead to 2020 I assume my original non-deductible contribution is now $4,950 ($5,550 - $550) so when I got through this again, I'm using that as the amount to base the pro-rata calculation on.

Are my assumptions and math correct?

Part Two: (not related to pro rata)

Looking forward I see an "issue" that might be considered a good problem to have. My above example is sample numbers but $10,000 is the number I'm going with for 2019 since this process is a first for me and we need to be careful to not increase our income too much with conversions. If I continue with just $10,000 per year compared to what my traditional IRA is currently earning per year, my earnings will outpace my ability to convert it! Is anyone else experiencing this "problem"?
Last edited by jeffreys on Sun Dec 29, 2019 12:43 pm, edited 1 time in total.
livesoft
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Re: Roth Conversion Pro Rata Math

Post by livesoft »

Part 1: Yes, except "rollover" means something different and you are doing a conversion. If you try to answer tax-prep software questions and mix up rollover and conversion terms, then you might get messed up.

This is all done for you if you fill out Form 8606 which you will have to do. Since you already have non-deductible tIRA contributions you have already gotten used to Form 8606 in the past. Form 8606 is rather short and easy to fill out, but only if you read it and its instructions. I see evidence that many people don't even want to read the form nor its instructions, so they start splattering numbers on the form and hope that is good enough. I suggest that you don't use the splatter approach to this form.

Part 2: You can always convert under current law until your tIRA ends up with zero balance or you die.
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Topic Author
jeffreys
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Re: Roth Conversion Pro Rata Math

Post by jeffreys »

Yes, except "rollover" means something different and you are doing a conversion.
Thanks for pointing that out. I edited my post to say "conversion" because that is what this actually is (I'm constantly swapping those terms and need to be more careful).

The non-deductible portion was from 2017 when we had a capital gain and weren't aware that could push us out of Roth eligibility and we have to recharacterize our contributions. Hubby was able to convert his immediately because his IRA was all Roth. Mine is much more complex as I have a mix of the two.

Since understanding this better we've been careful to make sure we stay within Roth eligibility though if we bump out again, I'm comfortable dealing with pro rata and tracking it in my many spreadsheets I keep.
livesoft
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Re: Roth Conversion Pro Rata Math

Post by livesoft »

kriskd wrote: Sun Dec 29, 2019 12:46 pm..., I'm comfortable dealing with pro rata and tracking it in my many spreadsheets I keep.
One of my points is that spreadsheets are not needed if Form 8606 is used as it is required to be used by IRS. One only needs to have their latest Form 8606 and one is good to go.
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Alan S.
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Re: Roth Conversion Pro Rata Math

Post by Alan S. »

kriskd wrote: Sun Dec 29, 2019 12:36 pm Part One:

Part Two: (not related to pro rata)

Looking forward I see an "issue" that might be considered a good problem to have. My above example is sample numbers but $10,000 is the number I'm going with for 2019 since this process is a first for me and we need to be careful to not increase our income too much with conversions. If I continue with just $10,000 per year compared to what my traditional IRA is currently earning per year, my earnings will outpace my ability to convert it! Is anyone else experiencing this "problem"?
Not sure what you mean here.

Assuming you want to convert 10,000. That .055 factor you referred to will change each year. If your IRA has investment losses the factor will be higher than if you have investment gains. Gains do not change your basis, but they do reduce the % that your remaining basis (line 14 of Form 8606) represents of your total balance.

Therefore, after a year of gains you non taxable portion could be lower than .055, meaning that a 10,000 conversion would have a higher taxable amount. After a year of losses your 10,000 conversion would have a higher NON taxable amount.

If you want 10,000 to be your taxable amount which is added to your AGI, you should gross up the 10000 by dividing it by (1-non taxable fraction).

10000/1-.055 = 10,582. Again, the .055 will change in most years due to gains or losses.
Topic Author
jeffreys
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Joined: Wed Jan 24, 2018 7:46 pm

Re: Roth Conversion Pro Rata Math

Post by jeffreys »

Not sure what you mean here.
Part two wasn't really a question or concern more of a fun observation. I was just stating my tIRA is growing so fast that if I continue to convert so little each year (regardless of the pro rata calculation I have to deal with) I'll never get it completely converted. I realize that 2019 has been an exceptional year for growth and in a down year a $10,000 conversion will represent a higher percentage and maybe down the road I can convert more at once. I'm just stating that if it continues to grow at its current rate or even a little slower I don't see how I could ever get the entire thing converted at $10,000 a year.

A good problem to have!
Topic Author
jeffreys
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Joined: Wed Jan 24, 2018 7:46 pm

Re: Roth Conversion Pro Rata Math

Post by jeffreys »

For reference, here is a very similar question to mine where someone spelled out the math for subsequent years: viewtopic.php?t=239356#p3743387
jimcrawford01
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Re: Roth Conversion Pro Rata Math

Post by jimcrawford01 »

You have a number of posts mention Form 8606.
If you REALLY wish to understand this and related subjects, take a few practice trips through the Form 8606 and consult the Form 8606 Instructions.
A VERY valuable experience.
Topic Author
jeffreys
Posts: 113
Joined: Wed Jan 24, 2018 7:46 pm

Re: Roth Conversion Pro Rata Math

Post by jeffreys »

Pulled the trigger on the Roth conversion! Going to make an estimated tax payment prior to the January 15 to ensure we don't get an underpayment penalty come tax-filing time.

No turning back now! :D
Topic Author
jeffreys
Posts: 113
Joined: Wed Jan 24, 2018 7:46 pm

Re: Roth Conversion Pro Rata Math

Post by jeffreys »

Follow-up. We just completed the first run-through of our taxes with Turbo Tax. The way we do taxes is hubby operates the software and I am responsible for document gathering. When we got to the Roth conversion portion (Form 8606) he couldn't figure out how to enter our numbers via the "wizard". I asked him to print Form 8606 (which was wrong of course) for me and then with a little help from Google I corrected it in pencil and handed it back to him to somehow enter back into Turbo Tax. What he ended up doing was editing line 2 of the actual Form 8606 within Turbo Tax and once he did that, the numbers on the form fell into place and even matched the "chicken scratched" I had done with paper/pencil! So we're pretty excited that we're essentially done with the federal form and are confident with our Form 8606.
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