Roth Conversion 5yr Holding Period?

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goingup
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Roth Conversion 5yr Holding Period?

Post by goingup » Wed Aug 16, 2017 2:48 pm

Bogleheads-
I'm considering doing my first Roth conversion this year. I came across something on the Vanguard site that I didn't see in the BH Wiki. Vanguard mentions there is a 5 year holding period for the converted funds. Have any of you had experience with this?

"There's a 5-year holding period on withdrawals of money that were part of a Roth conversion. So if you think you'll need the money within that time, you could end up owing the taxes you were hoping to minimize with a conversion." https://investor.vanguard.com/ira/roth- ... on?lang=en

I'm 56 now and would plan to convert my Rollover IRA over 3-4 years. Does this mean each converted lump has a 5-yr holding period? That seems odd. How does someone keep track of that?

Lastly, I have read you can convert by just sliding shares over from the Rollover IRA to the Roth. No selling required. That sounds much easier than I thought. Is this how it is commonly done, provided a person uses other monies to pay the taxes?

Thanks for your feedback!

baughman
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Re: Roth Conversion 5yr Holding Period?

Post by baughman » Wed Aug 16, 2017 2:51 pm

The topic is discussed here:

http://rootofgood.com/roth-ira-conversi ... etirement/
http://www.madfientist.com/how-to-acces ... nds-early/

It's known as the "roth IRA conversion ladder"

bloom2708
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Re: Roth Conversion 5yr Holding Period?

Post by bloom2708 » Wed Aug 16, 2017 2:53 pm

I have this bookmarked. It is a good summary of one plan from rootofgood.com.

Previous poster beat me to it...

http://rootofgood.com/roth-ira-conversi ... etirement/
"We are here not to please but to provoke thoughtfulness" Unknown Boglehead

pobox2001
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Re: Roth Conversion 5yr Holding Period?

Post by pobox2001 » Wed Aug 16, 2017 3:18 pm

Keep in mind once you are 59 1/2, you don't need to wait the 5 years on converted funds (as you would already have an exemption for being 59 1/2).

For more info, see here:

https://www.kitces.com/blog/understandi ... nversions/

pobox2001

goingup
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Re: Roth Conversion 5yr Holding Period?

Post by goingup » Wed Aug 16, 2017 4:26 pm

Thanks for those articles. I understand now the strategy of the Roth Ladder but I don't think I'll be trying that. I'm just going to convert as much as possible each year and stay in 15% bracket. The aha thing I realized from pobox2001's post is once I'm 59 1/2 the 5-yr holding period is moot.

Thanks for the help with understanding the finer points of Roth conversions.

kaneohe
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Re: Roth Conversion 5yr Holding Period?

Post by kaneohe » Wed Aug 16, 2017 4:50 pm

pobox2001 wrote:
Wed Aug 16, 2017 3:18 pm
Keep in mind once you are 59 1/2, you don't need to wait the 5 years on converted funds (as you would already have an exemption for being 59 1/2).

For more info, see here:

https://www.kitces.com/blog/understandi ... nversions/

pobox2001
just for completeness so others don't get the wrong idea, here's a nice summary of the Roth withdrawal rules by kawill of the fairmark.com site.
At age 59.5, the 5 yr clock on each Roth conversion is replaced by a 5 yr clock on the first Roth IRA..........so if you turn 59.5 but you just recently did your first Roth contribution(or conversion) and the account is not yet 5 yrs old, you can remove any contributions and converted funds, but any earnings withdrawn will be taxed. Since contributions and conversions are considered to be withdrawn first,this will generally not be a problem
unless you withdraw everything.

********************************************************************************************************************
Re: Roth IRA Rules - Table Approach
Posted by: KAWill (IP Logged)
Date: October 14, 2010 11:57PM


Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

No Taxes
No Penalties

Note: The table is not applicable to timely distributions of excess contributions or return of regular contributions.

goingup
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Re: Roth Conversion 5yr Holding Period?

Post by goingup » Thu Aug 17, 2017 10:57 am

kaneohe wrote:
Wed Aug 16, 2017 4:50 pm
pobox2001 wrote:
Wed Aug 16, 2017 3:18 pm
Keep in mind once you are 59 1/2, you don't need to wait the 5 years on converted funds (as you would already have an exemption for being 59 1/2).

For more info, see here:

https://www.kitces.com/blog/understandi ... nversions/

pobox2001
just for completeness so others don't get the wrong idea, here's a nice summary of the Roth withdrawal rules by kawill of the fairmark.com site.
At age 59.5, the 5 yr clock on each Roth conversion is replaced by a 5 yr clock on the first Roth IRA..........so if you turn 59.5 but you just recently did your first Roth contribution(or conversion) and the account is not yet 5 yrs old, you can remove any contributions and converted funds, but any earnings withdrawn will be taxed. Since contributions and conversions are considered to be withdrawn first,this will generally not be a problem
unless you withdraw everything.

********************************************************************************************************************
Re: Roth IRA Rules - Table Approach
Posted by: KAWill (IP Logged)
Date: October 14, 2010 11:57PM


Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

No Taxes
No Penalties

Note: The table is not applicable to timely distributions of excess contributions or return of regular contributions.
Thanks kaneohe-
That table is quite complete. In my case I won't have any new Roths to worry about, just conversions. I won't need to tap these monies before 59 1/2. The main goal now is to figure out how to minimize tax owed for the conversions.

Miriam2
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Re: Roth Conversion 5yr Holding Period?

Post by Miriam2 » Thu Aug 17, 2017 10:14 pm

kaneohe wrote:just for completeness so others don't get the wrong idea, here's a nice summary of the Roth withdrawal rules by kawill of the fairmark.com site...
Kaneohe, you're the greatest 8-) Very helpful list, thank you for posting.

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celia
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Re: Roth Conversion 5yr Holding Period?

Post by celia » Fri Aug 18, 2017 3:25 am

goingup wrote:
Wed Aug 16, 2017 2:48 pm
I'm 56 now and would plan to convert my Rollover IRA over 3-4 years. Does this mean each converted lump has a 5-yr holding period? That seems odd. How does someone keep track of that?
No. You only need to track the first one.
Lastly, I have read you can convert by just sliding shares over from the Rollover IRA to the Roth. No selling required. That sounds much easier than I thought. Is this how it is commonly done, provided a person uses other monies to pay the taxes?
On Vanguard, you can exchange shares of fund A in a TIRA for shares of fund A in a new (empty) Roth. I think you have to open the Roth first by mail or online. Once you have one Roth account, future conversions can be done into a new (empty) Roth and they will automatically copy the attributes (your name, address, beneficiaries, brokerage account/mutual fund account) of the first Roth to generate the second one.

Note that it is recommended to always convert into a new (empty) Roth since it will make recharacterizations easier. If you convert into an existing Roth, then decide to recharacterize (because the markets dropped or you can't pay the whole tax), you risk having part of the existing Roth go back to the TIRA along with the amount you converted.

One other thing that should be mentioned is that if you have any kind of tax-deferred IRAs with non-deductible contributions in them, the conversion will be partly tax-free. But the calculations will get "ugly" each year as all the non-Roth IRAs are considered co-mingled for conversion purposes and some of the non-deductible contributions, which will not be taxed again, will be part of every conversion or distribution/RMD from then on.

The things you need to know before converting can be found on our wiki page: https://www.bogleheads.org/wiki/Roth_IRA_conversion
Last edited by celia on Fri Aug 18, 2017 4:09 am, edited 1 time in total.

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celia
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Re: Roth Conversion 5yr Holding Period?

Post by celia » Fri Aug 18, 2017 3:44 am

goingup wrote:
Thu Aug 17, 2017 10:57 am
The main goal now is to figure out how to minimize tax owed for the conversions.
1. Convert when the markets crash. Really! If you want to convert 100 shares of Fund X at $50 now and next month the shares are worth $25, convert then. I think of it as "stocks (and conversion taxes) are on sale". If you have already converted earlier in the year, leave the first conversion there and do a second one. (This is the "leap frog" method.) You can later recharacterize the first conversion at the end of the year or in the following year (up to October 15).

2. Convert more when you have more room available in the lower tax brackets. You may want to delay SS or tax-loss harvest or find more itemized deductions for this to be most useful.

3. Convert using the "horse race" method or "leap frog" as described elsewhere in this forum. Note: These are nicknames likely only used in the Bogleheads forum.

4. See Complex (profitable?) Roth Conversion Strategy.

cherijoh
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Re: Roth Conversion 5yr Holding Period?

Post by cherijoh » Fri Aug 18, 2017 5:34 am

celia wrote:
Fri Aug 18, 2017 3:44 am
goingup wrote:
Thu Aug 17, 2017 10:57 am
The main goal now is to figure out how to minimize tax owed for the conversions.
1. Convert when the markets crash. Really! If you want to convert 100 shares of Fund X at $50 now and next month the shares are worth $25, convert then. I think of it as "stocks (and conversion taxes) are on sale". If you have already converted earlier in the year, leave the first conversion there and do a second one. (This is the "leap frog" method.) You can later recharacterize the first conversion at the end of the year or in the following year (up to October 15).

2. Convert more when you have more room available in the lower tax brackets. You may want to delay SS or tax-loss harvest or find more itemized deductions for this to be most useful.

3. Convert using the "horse race" method or "leap frog" as described elsewhere in this forum. Note: These are nicknames likely only used in the Bogleheads forum.

4. See Complex (profitable?) Roth Conversion Strategy.
+1
I think your #1 is underappreciated. I was underemployed during the Great Recession but had plenty of "dry tinder" to cover taxes. So I did a combination of Roth conversions and switching to passive index funds from legacy active funds (i.e., I was already investing new money in Indexes but had been holding on to some active funds because of significant embedded capital gains). When the economy recovered my Roth and my taxable accounts rebounded significantly.

cherijoh
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Re: Roth Conversion 5yr Holding Period?

Post by cherijoh » Fri Aug 18, 2017 5:34 am

celia wrote:
Fri Aug 18, 2017 3:44 am
goingup wrote:
Thu Aug 17, 2017 10:57 am
The main goal now is to figure out how to minimize tax owed for the conversions.
1. Convert when the markets crash. Really! If you want to convert 100 shares of Fund X at $50 now and next month the shares are worth $25, convert then. I think of it as "stocks (and conversion taxes) are on sale". If you have already converted earlier in the year, leave the first conversion there and do a second one. (This is the "leap frog" method.) You can later recharacterize the first conversion at the end of the year or in the following year (up to October 15).

2. Convert more when you have more room available in the lower tax brackets. You may want to delay SS or tax-loss harvest or find more itemized deductions for this to be most useful.

3. Convert using the "horse race" method or "leap frog" as described elsewhere in this forum. Note: These are nicknames likely only used in the Bogleheads forum.

4. See Complex (profitable?) Roth Conversion Strategy.
+1
I think your #1 is underappreciated. I was underemployed during the Great Recession but had plenty of "dry tinder" to cover taxes. So I did a combination of Roth conversions and switching to passive index funds from legacy active funds (i.e., I was already investing new money in Indexes but had been holding on to some active funds because of significant embedded capital gains). When the economy recovered my Roth and my taxable accounts rebounded significantly.

kaneohe
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Re: Roth Conversion 5yr Holding Period?

Post by kaneohe » Fri Aug 18, 2017 7:34 am

goingup wrote:
Wed Aug 16, 2017 2:48 pm
........................................................

I'm 56 now and would plan to convert my Rollover IRA over 3-4 years. Does this mean each converted lump has a 5-yr holding period? That seems odd. How does someone keep track of that?

..........................................................................
As you may have gathered from that kawill table, each conversion has it's own 5 yr clock. However due to your "advanced" age :happy , at age 59.5 the series of conversion clocks changes to a 5yr clock for 1st Roth opened . If the conversion was your 1st Roth, then only the first one matters. If you had other Roths previously, the oldest one matters.

In general ,you do need to keep track of each conversion, withdrawals,contributions,etc. If you are a record keeper, that should not be a problem.
If not, .............

ryman554
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Re: Roth Conversion 5yr Holding Period?

Post by ryman554 » Fri Aug 18, 2017 8:35 am

celia wrote:
Fri Aug 18, 2017 3:44 am
1. Convert when the markets crash. Really! If you want to convert 100 shares of Fund X at $50 now and next month the shares are worth $25, convert then. I think of it as "stocks (and conversion taxes) are on sale". If you have already converted earlier in the year, leave the first conversion there and do a second one. (This is the "leap frog" method.) You can later recharacterize the first conversion at the end of the year or in the following year (up to October 15).
There is an exception to this -- if you are converting the entire account with a sizeable after-tax basis.

That basis goes away if you convert it all. If you have a market drop, and you have more basis than tIRA value, you need to maintain a tIRA balance to keep unused basis for the next year.

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celia
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Re: Roth Conversion 5yr Holding Period?

Post by celia » Fri Aug 18, 2017 2:32 pm

ryman554 wrote:
Fri Aug 18, 2017 8:35 am
celia wrote:
Fri Aug 18, 2017 3:44 am
1. Convert when the markets crash. Really! If you want to convert 100 shares of Fund X at $50 now and next month the shares are worth $25, convert then. I think of it as "stocks (and conversion taxes) are on sale". If you have already converted earlier in the year, leave the first conversion there and do a second one. (This is the "leap frog" method.) You can later recharacterize the first conversion at the end of the year or in the following year (up to October 15).
There is an exception to this -- if you are converting the entire account with a sizeable after-tax basis.

That basis goes away if you convert it all. If you have a market drop, and you have more basis than tIRA value, you need to maintain a tIRA balance to keep unused basis for the next year.
Why do you need to keep some basis for following years? Isn't the point to convert as much as you can as early as you can?
For example, say I have a basis of $50,000 in a TIRA that is worth $60,000. I convert now and pay taxes on $10,000.
Or if I convert when the market brings the TIRA value down to $30,000, I still have a $50,000 basis. I can convert and use up $30,000 of basis (pay no taxes) and have a basis of $20,000 still remaining that I can use in the future (when more tax-deferred money ends up in the IRA). Can't I?

Ryman, please give another example if I miss your point.

OP, I apologize if we're taking the thread topic off course. But this is important for us to know.
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.

kaneohe
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Re: Roth Conversion 5yr Holding Period?

Post by kaneohe » Fri Aug 18, 2017 2:57 pm

celia wrote:
Fri Aug 18, 2017 2:32 pm
Why do you need to keep some basis for following years? Isn't the point to convert as much as you can as early as you can?
For example, say I have a basis of $50,000 in a TIRA that is worth $60,000. I convert now and pay taxes on $10,000.
Or if I convert when the market brings the TIRA value down to $30,000, I still have a $50,000 basis. I can convert and use up $30,000 of basis (pay no taxes) and have a basis of $20,000 still remaining that I can use in the future (when more tax-deferred money ends up in the IRA). Can't I?

.........................................................
[/quote]

celia, I think Ryman is saying that if the TIRA value is 30K and you convert 30K so the account value is 0, then the remainder of the basis may disappear. Why that would happen but not happen if the account value is $1 I don't know. And does the basis disappear if the account value is 0
or if the account is closed w/ value 0?

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celia
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Re: Roth Conversion 5yr Holding Period?

Post by celia » Fri Aug 18, 2017 3:39 pm

kaneohe wrote:
Fri Aug 18, 2017 2:57 pm
celia, I think Ryman is saying that if the TIRA value is 30K and you convert 30K so the account value is 0, then the remainder of the basis may disappear. Why that would happen but not happen if the account value is $1 I don't know. And does the basis disappear if the account value is 0 or if the account is closed w/ value 0?
The basis does not rely on an account being open or not. It is tracked in Form 8606 that you carry forward each year on your tax return as long as there is any basis left.
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.

kaneohe
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Re: Roth Conversion 5yr Holding Period?

Post by kaneohe » Fri Aug 18, 2017 3:59 pm

Here's AlanS on a similar topic: viewtopic.php?t=209496

Re: IRA basis question
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Post by Alan S. » Sun Jan 29, 2017 8:00 pm

It is generally correct that if your balance is 0 you have no basis. One rare exception would be if your balance is 0 because your investment(s) became worthless. In that case, your last 8606 will still indicate a basis on line 14 if you had one entering the year.

If you have a higher basis than value in your IRA or Roth IRA (much more likely in Roth) and cannot use the misc deduction like most people, you should not take a full distribution. If you are doing a conversion, leave a few bucks in your TIRA. This will trigger Part I of the 8606 and preserve your basis for future use on line 14 of that 8606.

You can also dial up a Part I by making a non deductible contribution for the tax year, even if you converted your entire TIRA earlier in that year.

Utilizing this preserved basis may require some planning. For example, if you have a 401k and you are eligible to take a partial distribution of pre tax money, you could do a direct rollover of the pre tax money to your TIRA equal to your latest line 14 basis, then convert this amount tax free. You will then have moved your basis from your TIRA to your Roth IRA.

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celia
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Re: Roth Conversion 5yr Holding Period?

Post by celia » Fri Aug 18, 2017 7:19 pm

kaneohe wrote:
Fri Aug 18, 2017 3:59 pm
Here's AlanS on a similar topic: viewtopic.php?t=209496
.
.
Ouch! That thread gave me a headache. It mainly dissected Form 8606 which calculates how much of a conversion is taxable (among other things).

In summary, if you did a partial conversion and have a basis (made non-deductible contributions at some time), you go through Part 1 of the form to do the pro rata calculation and determine how much of the conversion is taxable and how much of your basis remains (on line 14).

If you converted the entire account (and have no other traditional, SEP and SIMPLE IRAs) and didn't add to your basis that year, you go through Part 2 of the form. It then subtracts your basis from the converted amount. If the result is positive, the value gets taxed. There is no mention of what to do with a negative amount (when the basis is more that the value of the account). It appears to be just thrown away. :(

The consensus, then, is that it is better to make the calculations go through Part 1 to record your remaining basis whenever you convert.
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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Re: Roth Conversion 5yr Holding Period?

Post by Alan S. » Sat Aug 19, 2017 9:41 pm

celia wrote:
Fri Aug 18, 2017 7:19 pm
kaneohe wrote:
Fri Aug 18, 2017 3:59 pm
Here's AlanS on a similar topic: viewtopic.php?t=209496
.
.
Ouch! That thread gave me a headache. It mainly dissected Form 8606 which calculates how much of a conversion is taxable (among other things).

In summary, if you did a partial conversion and have a basis (made non-deductible contributions at some time), you go through Part 1 of the form to do the pro rata calculation and determine how much of the conversion is taxable and how much of your basis remains (on line 14).

If you converted the entire account (and have no other traditional, SEP and SIMPLE IRAs) and didn't add to your basis that year, you go through Part 2 of the form. It then subtracts your basis from the converted amount. If the result is positive, the value gets taxed. There is no mention of what to do with a negative amount (when the basis is more that the value of the account). It appears to be just thrown away. :(

The consensus, then, is that it is better to make the calculations go through Part 1 to record your remaining basis whenever you convert.
This is correct. If Part I is completed your remaining basis shows on line 14.

The Form 8606 Inst are designed to reflect Sec 408(d)(2) of the tax code dealing with application of Sec 72 (basis application) for IRA accounts:
(2)Special rules for applying section 72For purposes of applying section 72 to any amount described in paragraph (1)—
(A)all individual retirement plans shall be treated as 1 contract,
(B)all distributions during any taxable year shall be treated as 1 distribution, and
(C)the value of the contract, income on the contract, and investment in the contract shall be computed as of the close of the calendar year in which the taxable year begins.
For purposes of subparagraph (C), the value of the contract shall be increased by the amount of any distributions during the calendar year.
Note that basis is referred to as "investment in the contract" above. Form 8606 does the computation accordingly, but Part I must be completed in order to have remaining basis listed on line 14 for carryover to future years.

If you distribute or convert your entire TIRA balance, Part I is not completed unless you also make a ND contribution for that year. If you do not want to make a ND contribution or have no earned income to support the contribution, you must not do a total distribution or conversion. Leave at least $1 in your TIRA, and Part I will be completed and your unrecovered basis lives on.

Now you have to determine how you will use this basis if your TIRA is down to $1. One way to do that if you still have a QRP in place is to do a partial direct rollover from the pre tax QRP to an IRA equal to your basis. You then convert that rollover amount to a Roth IRA tax free applying the remaining basis. If you do not do this while living your non spouse beneficiary cannot because a non spouse beneficiary cannot convert an inherited IRA even though they can do a direct rollover of an inherited QRP to an inherited IRA.

Another possible option is to close your TIRA in a year you can itemize and take the misc itemized deduction (subject to 2% AGI floor) for your unrecovered basis.

For most people, remaining basis is not worth the hassle of saving, and most people will not have a large unrecovered basis. But if you do, there are some options worth looking at that take some planning.

ryman554
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Re: Roth Conversion 5yr Holding Period?

Post by ryman554 » Sun Aug 20, 2017 2:48 pm

Alan S. wrote:
Sat Aug 19, 2017 9:41 pm
Now you have to determine how you will use this basis if your TIRA is down to $1. One way to do that if you still have a QRP in place is to do a partial direct rollover from the pre tax QRP to an IRA equal to your basis. You then convert that rollover amount to a Roth IRA tax free applying the remaining basis. If you do not do this while living your non spouse beneficiary cannot because a non spouse beneficiary cannot convert an inherited IRA even though they can do a direct rollover of an inherited QRP to an inherited IRA.

Another possible option is to close your TIRA in a year you can itemize and take the misc itemized deduction (subject to 2% AGI floor) for your unrecovered basis.

For most people, remaining basis is not worth the hassle of saving, and most people will not have a large unrecovered basis. But if you do, there are some options worth looking at that take some planning.
There is another: get your income down to a year where you can *deduct* a contribution to an IRA. If there is basis left, you should be able to contribute to tIRA up to your basis with a full tax deduction AND convert to a ROTH with no tax owed due to the remaining basis.

But I do agree with the sense above that it would be "difficult" to have a large, unrecovered basis excepting the year 2008, where it would have been "cheap" to do roth conversions (were they allowed) when valuations were down 50%.

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