Author Topic: Rollover after-tax basis in tIRA to Roth? Any gotchas?  (Read 1717 times)

Sid Arthur

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Rollover after-tax basis in tIRA to Roth? Any gotchas?
« on: October 05, 2019, 03:38:35 PM »
For many years I have made non-deductible after-tax contributions to a traditional IRA in addition to maxing out my 401k. There was also one year when I was contracting and made a pre-tax contribution to this tIRA. I have been keeping track of the after-tax "basis" and reporting it to the IRS on form 8606. I did this based on some advice from long ago that this was a good way to let these savings grow tax tree - and since I earned above some limit and/or because I was contributing to a 401k I could not contribute to a Roth IRA.

I was assuming that I would have to leave this tIRA "as is" until I needed to withdraw funds and would have to pay the tax pro-rated based on the basis each time. But I saw this post: https://forum.mrmoneymustache.com/taxes/tira-poluded-with-non-deductible-contribution/ that makes me think I could do better by rolling over the after-tax portion into a Roth IRA and thus not have to pay tax on the gains on that portion from now on.

I am planning to retire in December this year and do the rollover in 2020 (when I'm no longer contributing to a 401k and will have a low taxable income). I will be 59.5 when I retire. My wife will be continuing to work, she is self employed and will be contributing to a Solo-401k.

As I understand the rules I would have to rollover all of the money in the existing tIRA.

Question 1: Do I do this by opening a new Roth IRA and rolling over the after tax portion into this and a opening new tIRA and rollover the remainder into this? It sounds like there would be no tax due from doing that.

Question 2: There is some rule about only doing one rollover per year. Does that apply to all kinds of rollover? I am planning to rollover from my current employer's 401k into my existing Fidelity Rollover IRA. Would I be allowed to do that in the same year that I rollover by tIRA?

Thanks in advance for any advice. I'm new here so would appreciate advice on any gotchas I might be missing. The first year of retirement is going to be fun will juggling IRAs, HSAs, ACA subsidies, capital gains etc to minimize taxes :)







I have a traditional IRA that I have been paying in the

seattlecyclone

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Re: Rollover after-tax basis in tIRA to Roth? Any gotchas?
« Reply #1 on: October 05, 2019, 04:21:40 PM »
Question 1: Do I do this by opening a new Roth IRA and rolling over the after tax portion into this and a opening new tIRA and rollover the remainder into this? It sounds like there would be no tax due from doing that.

No, it doesn't work this way. Traditional to Roth IRA conversions are prorated between the post-tax basis and pre-tax amounts. For example if your traditional IRA is 25% pre-tax and 75% post-tax, any amount you move to Roth will be considered to come 25% from the pre-tax portion of your traditional IRA and 75% from the post-tax basis. The pre-tax part will be taxed at your normal marginal rate in the year of the conversion.

What you can do is first roll the pre-tax amount to a workplace plan such as a 401(k). The pro-rata rule doesn't apply here because you're not allowed to move post-tax basis into these plans. Therefore the full amount is deemed to come from pre-tax funds since these can be rolled into 401(k)s. Once you have done this, the rest of the money in your traditional IRA will be post-tax. You'll then be able to move it to Roth for free, and any future growth of this money after you move it will also be tax-free.

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Question 2: There is some rule about only doing one rollover per year. Does that apply to all kinds of rollover? I am planning to rollover from my current employer's 401k into my existing Fidelity Rollover IRA. Would I be allowed to do that in the same year that I rollover by tIRA?

I think the one-rollover rule only applies to the type of rollover where you simply withdraw from one IRA and contribute to another within 60 days. My understanding is that direct rollovers (where the money goes straight from one IRA to another without first passing through your checking account) are not subject to this rule and you can do as many of these as you want.

Sid Arthur

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Re: Rollover after-tax basis in tIRA to Roth? Any gotchas?
« Reply #2 on: October 05, 2019, 06:00:18 PM »
Thanks for the answers!

I thought it sounded like it might be too good to be true. The IRS doc I can find is this one: https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans which makes it sound like it is limited to rollover's FROM a "defined contribution retirement plan" which I don't think would include my tIRA. But maybe I'm wrong about that.

So, if I can do it if I rollover the pretax part to a 401k, I wonder if my employer's 410k plan would allow that. I will do some research. I'm not sure if it would make a difference whether I do it before or after I retire.

So, would the pre-tax part that would rollover to the 401k include pre-tax contributions and the gains on ALL contributions? E.g. if I have 50k worth of after-tax contributions, 3k worth of pre-tax contributions and 40k worth of gains, would I rollover 43k to the 401k and 50k to the Roth?

seattlecyclone

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Re: Rollover after-tax basis in tIRA to Roth? Any gotchas?
« Reply #3 on: October 05, 2019, 07:24:15 PM »
I thought it sounded like it might be too good to be true. The IRS doc I can find is this one: https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans which makes it sound like it is limited to rollover's FROM a "defined contribution retirement plan" which I don't think would include my tIRA. But maybe I'm wrong about that.

That IRS doc is about what you can do if you already have after-tax amounts in a 401(k). It doesn't apply to your situation at all, as your after-tax basis is in a traditional IRA.

Traditional IRA to 401(k) rollovers are allowed, but only for pre-tax amounts. That's why this is a powerful tool: it lets you separate the pre-tax part of your IRA from the after-tax part. Once you have done this, the after-tax part can be converted to Roth all by itself.

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So, if I can do it if I rollover the pretax part to a 401k, I wonder if my employer's 410k plan would allow that. I will do some research. I'm not sure if it would make a difference whether I do it before or after I retire.

Not all 401(k)s accept incoming rollovers from traditional IRAs. If yours does, you'll probably need to make the rollover before you leave employment. I've never heard of an employer plan that allows former employees to make rollover contributions.

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So, would the pre-tax part that would rollover to the 401k include pre-tax contributions and the gains on ALL contributions? E.g. if I have 50k worth of after-tax contributions, 3k worth of pre-tax contributions and 40k worth of gains, would I rollover 43k to the 401k and 50k to the Roth?

Yes, exactly this.

Sid Arthur

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Re: Rollover after-tax basis in tIRA to Roth? Any gotchas?
« Reply #4 on: October 05, 2019, 11:45:48 PM »
Thanks, this looks like it could work. I have checked with my employer's 401k (administrated by Vanguard) and the plan says it does allow rollovers in from traditional IRAs.

However, I see one possible problem. I have a separate "rollover IRA" that I have rolled-over previous employer's 401ks into over the years. It sounds like this is considered a traditional IRA also. I'm not 100% sure but what I have read suggests that I have to consider all traditional IRAs combined when doing the rollover. i.e. to be able to separate the after-tax portion of my traditional IRA I would have to rollover not just the pre-tax portion of my ~100k traditional IRA but also all of my (much larger) rollover IRA to my 401k. Is this correct?





seattlecyclone

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Re: Rollover after-tax basis in tIRA to Roth? Any gotchas?
« Reply #5 on: October 06, 2019, 01:07:35 AM »
Yes, that's correct. The pro-rata rule is applied against the sum of all of your traditional IRA account balances.

Sid Arthur

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Re: Rollover after-tax basis in tIRA to Roth? Any gotchas?
« Reply #6 on: October 13, 2019, 05:43:38 PM »
Update (both to share info for others and so people can point out anything I have missed) :)

I am planning to go ahead with this plan before I quit my job in December. I have talked to both Fidelity (where my IRAs are) and Vanguard (which administers my employer's 401k plan). My advisor at Fidelity referred to the "Coffee in the Cream rule" which seems to be another term for the pro-rata rule for IRAs. Here are some links that I found:

https://www.fidelity.com/insights/retirement/what-is-a-backdoor-roth-ira
https://financialducksinarow.com/1707/turns-out-you-can-be-a-little-bit-pregnant/
https://www.magnifymoney.com/blog/investing/rollover-ira-to-401k/

My starting position is:

a) A rollover IRA at Fidelity (approx $750k). This is all pre-tax
b) A traditional IRA at Fidelity (approx $150k). About $60k of this is post-tax (I have the exact amount and have been reporting it as the basis to the IRS on form 8606)
c) A 401k with my current employer (approx $200k) (administered by Vanguard)
d) My earnings in 2019 will be too high to allow any regular Roth IRA contributions (not relevant to this process AFAIK)
e) I will be 59.5 at the end of the year (not relevant AFAIK)

So these are the steps that I plan to take:

1. Make my non-deductible IRA contribution of $7000 for 2019 to my Traditional IRA
2. Sell all stocks/bonds in both Fidelity IRAs so that everything is in cash reserves
3. Fill out two “One time withdrawal - IRA” forms with Fidelity (one for each of my IRAs)
    Each will check the box “Direct rollover to work place retirement plan (such as 401k)”
    The one for my rollover IRA will rollover all funds
    The one for my traditional IRA will rollover everything except the post tax ($67k)
    Have them send the checks to me but made payable to Vanguard FBO myself
4. Complete the online “Rollover money into this plan” on the Vanguard 401k site
5. Mail the rollover form and checks to Vanguard
6. Once the money has gone out of my Fidelity accounts do a Roth Conversion on my Traditional IRA
7. At this point I will have about $67k in the Roth IRA and $1,040k in 401k
7. Leave my company in December when I retire
8. There should be zero tax cost on my 2019 taxes for this process (though I will have to file the right form 8606)
8. After leaving (probably in 2020) rollover my 401k back to Fidelity into a new rollover IRA

In some ways all this effort seems a lot to get a small percentage of my retirement savings into a Roth IRA. But my thought process is:
a) It gets this amount out of RMD consideration thus reducing the RMDs when I hit 70.5
b) All future growth on this $60k will be non-taxable on withdrawal (it would not be if left in the traditional IRA)
c) I would probably not touch this money until after all other funds since it has no RMDs and is growing tax free

I’m curious what I will put on my 8606 for 2019. I guess I use line 8 to give the amount I converted to Roth and line 14 (total basis in traditional IRAs at the end of the year) should come out to zero. Also the taxable amounts (line 15c and 18 should be zero).

So that’s the plan. I’ll let you know how it goes!

MDM

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Re: Rollover after-tax basis in tIRA to Roth? Any gotchas?
« Reply #7 on: October 13, 2019, 11:11:54 PM »
I’m curious what I will put on my 8606 for 2019. I guess I use line 8 to give the amount I converted to Roth and line 14 (total basis in traditional IRAs at the end of the year) should come out to zero. Also the taxable amounts (line 15c and 18 should be zero).
Tax software should handle this for you, but many have observed that the software Q&A can lead filers astray.

You might fill a practice 8606 by hand, and use the 'Form8606' tab in the case study spreadsheet to double-check, so that by the time you file next year you know how the software-generated form should look.