pro-rata rule and IRA conversion question

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afr
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pro-rata rule and IRA conversion question

Post by afr » Sat Mar 07, 2020 12:18 pm

My wife and I have been contributing after-tax income(we’re both W-2’s) to non-deductible TIRA’s(in addition to a joint taxable account) with Vanguard for the past 10 yrs. We each also have much smaller Roth IRA’s with VG when we first opened the accounts since we qualified under the income limits at the time. I have a no-match401k through my work that doesn’t allow any rollover(my wife has none) that I contribute in order to reduce my taxable income. If we were to convert our TIRA’s to our existing Roth IRA’s we won’t be subject to the pro-rata rule? We have never had SEP or SIMPLE accounts either.

MarkVH0518
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Re: pro-rata rule and IRA conversion question

Post by MarkVH0518 » Sat Mar 07, 2020 12:53 pm

You'll need to pay taxes on the gains. So yes, pro-rata is necessary.
My original post was incorrect.
Last edited by MarkVH0518 on Sat Mar 07, 2020 3:24 pm, edited 1 time in total.

Topic Author
afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Sat Mar 07, 2020 1:13 pm

Yes, I've been submitting 8606 for all of the non-deductible TIRA contributions. I don't think we were ever able to make any deductible contributions due to the income limit, though I'll have to check to be certain. But even if we did for possibly one year, why would it matter since all of our contributions were always made with after tax dollars.

Alan S.
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Re: pro-rata rule and IRA conversion question

Post by Alan S. » Sat Mar 07, 2020 1:16 pm

afr wrote:
Sat Mar 07, 2020 12:18 pm
My wife and I have been contributing after-tax income(we’re both W-2’s) to non-deductible TIRA’s(in addition to a joint taxable account) with Vanguard for the past 10 yrs. We each also have much smaller Roth IRA’s with VG when we first opened the accounts since we qualified under the income limits at the time. I have a no-match401k through my work that doesn’t allow any rollover(my wife has none) that I contribute in order to reduce my taxable income. If we were to convert our TIRA’s to our existing Roth IRA’s we won’t be subject to the pro-rata rule? We have never had SEP or SIMPLE accounts either.
Unless you converted all these ND contributions instantly, and particularly if the contributions have been sitting in a TIRA for some time, then your IRAs have generated possibly substantial earnings which are pre tax. Conversion now will be subject to the pro rata calculation using all non Roth IRA balances of each spouse separately.

Example: 20,000 of ND contributions, 10,000 of gains and therefore total value of 30,000. Each conversion amount will be 1/3 taxable.

NOTE: For taxable conversion purposes, gains on ND contributions are treated in the same manner as a deductible contribution - both are pre tax and therefore will be taxed if converted. Look at line 14 of your last 8606 for each spouse and compare that figure with the latest total value of all non Roth IRAs of each spouse.

Topic Author
afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Sat Mar 07, 2020 1:43 pm

Line 14 on my 8606 was 66,000 and thecurrent value of my non-ded. TIRA is 121,044. My wife's basis is 53,000 and the current value of her non-ded. TIRA is 95,000.

Alan S.
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Re: pro-rata rule and IRA conversion question

Post by Alan S. » Sat Mar 07, 2020 2:33 pm

afr wrote:
Sat Mar 07, 2020 1:43 pm
Line 14 on my 8606 was 66,000 and thecurrent value of my non-ded. TIRA is 121,044. My wife's basis is 53,000 and the current value of her non-ded. TIRA is 95,000.
With these figures, a total conversion would result in about 97,000 being taxable.

If either of you are working and your employer plan accepts IRA rollovers, you could eliminate the tax bill by rolling the pre tax amount of each spouse's IRA into the employer plan, then convert the remaining IRA basis tax free.

If that isn't possible or practical, then perhaps you convert one spouse's TIRA this year and the other next year to split the taxable amount over the 2 years. But when your basis % is this high, you should try to get that basis into your Roth IRA as soon as reasonably practical.

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afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Sat Mar 07, 2020 4:30 pm

Suppose we're going to have to wait til I retire in 7 yrs. and will more than likely be in a lower tax bracket to make gradual conversions. Otherwise its much too costly at the present time.

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celia
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Re: pro-rata rule and IRA conversion question

Post by celia » Sat Mar 07, 2020 5:07 pm

afr wrote:
Sat Mar 07, 2020 4:30 pm
Suppose we're going to have to wait til I retire in 7 yrs. and will more than likely be in a lower tax bracket to make gradual conversions. Otherwise its much too costly at the present time.
You may be in a lower tax bracket then or maybe not, depending on what your sources of income will be—pensions, SS, RMDs, dividends, etc. Have you estimated your age 70 taxes and later? You might be surprised. It would be well worth your time to know this now.

But during the next 7 years, the TIRA growth will continue (overall). Wouldn’t you want some of that growth to happen in Roth where it won’t be taxed any more?

To understand the pro-rata rule for calculating taxes and in understanding Backdoor Roth’s overall, I recommend you read our
Backdoor Roth wiki page.

Note that since you have both post-tax contributions (basis) and pre-tax growth in the TIRAs, the pro rata rule will apply to any withdrawal (whether RMDs, distributions to taxable, or Roth conversions) until the accounts are emptied out (and even after you die). If it was me, after I knew the future tax rates, I would probably make a plan for converting the smaller IRA over 3 Years or so.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

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celia
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Re: pro-rata rule and IRA conversion question

Post by celia » Sat Mar 07, 2020 5:21 pm

(I messed up and edited the wrong post. The following post quotes what was here.)
Last edited by celia on Sat Mar 07, 2020 11:34 pm, edited 2 times in total.

Topic Author
afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Sat Mar 07, 2020 5:29 pm

celia wrote:
Sat Mar 07, 2020 5:21 pm
afr wrote:
Sat Mar 07, 2020 1:43 pm
Line 14 on my 8606 was 66,000 and thecurrent value of my non-ded. TIRA is 121,044. My wife's basis is 53,000 and the current value of her non-ded. TIRA is 95,000.
If these account values didn’t change, this means that 66,000 / 121,044 = 54.5 % of any Roth conversion from your IRA would be tax-free. For your wife’s account, 53,000 / 95,000 = 55.7% of a conversion would be tax free.

The money remaining in the IRA would have the same proportions (since all dollars are considered co-mingled) although the pre-tax amount will change over time as more growth happens.
So if we each convert a little over 1/2 our non-deductible TIRA accounts to our existing Roth IRA accounts it'll cost us nothing tax-wise?

kaneohe
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Re: pro-rata rule and IRA conversion question

Post by kaneohe » Sat Mar 07, 2020 5:43 pm

afr wrote:
Sat Mar 07, 2020 5:29 pm
celia wrote:
Sat Mar 07, 2020 5:21 pm
afr wrote:
Sat Mar 07, 2020 1:43 pm
Line 14 on my 8606 was 66,000 and thecurrent value of my non-ded. TIRA is 121,044. My wife's basis is 53,000 and the current value of her non-ded. TIRA is 95,000.
If these account values didn’t change, this means that 66,000 / 121,044 = 54.5 % of any Roth conversion from your IRA would be tax-free. For your wife’s account, 53,000 / 95,000 = 55.7% of a conversion would be tax free.

The money remaining in the IRA would have the same proportions (since all dollars are considered co-mingled) although the pre-tax amount will change over time as more growth happens.
So if we each convert a little over 1/2 our non-deductible TIRA accounts to our existing Roth IRA accounts it'll cost us nothing tax-wise?
No..............think of your non-deductible contributions as a colored liquid and the growth as clear. The mixture is mixed uniformly together and you cannot separate out the component parts when you do a Roth conversion so you get a pro-rata share of each............a little over half is tax-free and the rest is taxable.

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celia
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Re: pro-rata rule and IRA conversion question

Post by celia » Sat Mar 07, 2020 11:23 pm

No, each dollar in the IRAs is considered to be partly post-tax (basis) and partly pre-tax. When you convert, the converted amount contains some of each. And the money remaining in the IRA contains some of each.

See the wiki page for several examples of calculating the tax-free part and the taxed part.

Topic Author
afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Sun Mar 08, 2020 9:32 am

Looks rather complicated.

lakpr
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Re: pro-rata rule and IRA conversion question

Post by lakpr » Sun Mar 08, 2020 9:42 am

Not sure if I missed it, but have you considered using the non-deductible IRA as the repository for bonds and your 401k as the repository for stocks? This will limit growth within the n-d-tIRA. If in the future you get access to a 401k that would allow roll overs, you can then switch that tactic around.

You can also consider having a side job, now or in your retiremen, that would produce some income; uber or Lyft driving qualifies. Then you can establish a Solo 401k for such self employed income, roll the pretax portion into it, and convert the non-deductible portion to Roth IRA.

Just some ideas.

Topic Author
afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Sun Mar 08, 2020 11:29 am

lakpr wrote:
Sun Mar 08, 2020 9:42 am
Not sure if I missed it, but have you considered using the non-deductible IRA as the repository for bonds and your 401k as the repository for stocks? This will limit growth within the n-d-tIRA. If in the future you get access to a 401k that would allow roll overs, you can then switch that tactic around.

You can also consider having a side job, now or in your retiremen, that would produce some income; uber or Lyft driving qualifies. Then you can establish a Solo 401k for such self employed income, roll the pretax portion into it, and convert the non-deductible portion to Roth IRA.

Just some ideas.
Unfortunately I have no control(pooled office account managed my Raymond James) over my 401k and am not able to make any rollovers. I can elect to either participate with or not. Its mainly 60% equity/40%fixed. I only participate since it helps reduce my taxable income(I'm W-2 ).

kaneohe
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Re: pro-rata rule and IRA conversion question

Post by kaneohe » Sun Mar 08, 2020 12:27 pm

afr wrote:
Sun Mar 08, 2020 9:32 am
Looks rather complicated.
https://www.irs.gov/pub/irs-prior/f8606--2019.pdf

You might find actually filling out the form for your particular situation less complicated than trying to understand the general problem. Just 1 step at a time following instructions on the form...................

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afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Tue Mar 17, 2020 11:43 am

I'm still quite confused calculating the cost of converting all of our TIRA's to a Roth. The current value of my TIRA is $102,400(basis of $66,000) and my wife's is $80,367(basis of $53,000). Anyone?

kaneohe
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Re: pro-rata rule and IRA conversion question

Post by kaneohe » Tue Mar 17, 2020 12:02 pm

afr wrote:
Tue Mar 17, 2020 11:43 am
I'm still quite confused calculating the cost of converting all of our TIRA's to a Roth. The current value of my TIRA is $102,400(basis of $66,000) and my wife's is $80,367(basis of $53,000). Anyone?
The basis of your TIRA is 66K. The total value includes your non-deductible contributions (basis) and earnings. The earnings are taxable at your marginal tax rate.

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afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Tue Mar 17, 2020 12:32 pm

Thanks. So it'll cost us over 15k to convert. Think I'll wait til we retire into the 15% bracket.

kaneohe
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Re: pro-rata rule and IRA conversion question

Post by kaneohe » Tue Mar 17, 2020 2:22 pm

afr wrote:
Tue Mar 17, 2020 12:32 pm
Thanks. So it'll cost us over 15k to convert. Think I'll wait til we retire into the 15% bracket.
tricky decision..........if you wait the market may be back up so even tho your tax rate is lower, your gains
may be higher, making the total tax the same or more. The real solution is if you have a 401K that will
accept your pre-tax funds. That would isolate the basis and you could convert tax free.

Topic Author
afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Tue Mar 17, 2020 4:22 pm

Unfortunately the 401k is a pooled office account. Unable to make any rollovers.

Topic Author
afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Mon Mar 23, 2020 4:39 pm

I don't get it. The market's in the toilet but I've got to wait til its down to the level of my basis to cost me nothing tax wise?
Last edited by afr on Wed Mar 25, 2020 10:25 am, edited 1 time in total.

kaneohe
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Re: pro-rata rule and IRA conversion question

Post by kaneohe » Mon Mar 23, 2020 6:44 pm

did you try doing the 8606 to see how much is taxable..........there will be some uncertainty since they yr end value comes into the calculation (obviously unknown at present).

Topic Author
afr
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Re: pro-rata rule and IRA conversion question

Post by afr » Wed Mar 25, 2020 10:48 am

Yep. Current value of my non Roth IRA is 104,280, basis of 66,000 and 24% federal income tax. Would cost me over 9,000 to convert it all. Might as well wait til I retire in another 7 yrs. and I should be in the 12% bracket by then.

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