Blog Site of ExactCPA.com, the #1 Online Tax CPA with over 190 5-Star Reviews

by **ps56k** » Sun Aug 25, 2013 7:11 pm

I've been looking at the subject of a conversion from Traditional IRA to the Roth IRA, some of the other issues as mentioned/learned in another thread.

This one is specifcally about the concept of the conversion, the "non-deductible basis", and the tax to be paid.
SO -
First scenario - $100k mkt value, $30k paid non-deductible contribs across the years, 25% current tax rate
so, if you convert this account, it would be $100k - $30k = $70k x 25% tax = $17.5k tax bill - correct ??

I'm confused on the concept of where the tax is being applied -
on the "growth or gains" of the account, ala divs, etc ?

What about the fully deductible account - same general numbers -
$100k mkt value - $0 for non-deductible amounts but same $30k contribs, 25% current tax rate
so, if you convert this account, it would be $100k - $0k = $100k x 25% tax = $25k tax bill - correct ??

BUT WHY - why are you taxed on the ENTIRE amount, and not just the usual "gains" like any investment ??

by **williamg** » Sun Aug 25, 2013 7:38 pm

Contingent on holding periods and age, you are only taxed on contributions that were not taxed when you made them. All other contributions and gains, both capital and dividend/interest, are not taxable.

by **littlebird** » Sun Aug 25, 2013 8:06 pm

williamg wrote:Contingent on holding periods and age, you are only taxed on contributions that were not taxed when you made them. All other contributions and gains, both capital and dividend/interest, are not taxable.

I don't believe this can be true. Trad IRAs are taxed on the entire amount *coming out*. Roth IRAs are taxed on the entire amount before *going in*. If you took out untaxed increase from a trad IRA and didn't pay tax before putting it in the Roth and then, because it's a Roth, you didn't pay tax on it *coming out*, you'd have never paid tax on the increase. What a deal that would be after 30 or 40 years!

by **kaneohe** » Sun Aug 25, 2013 9:11 pm

littlebird is correct. When you do the conversion you need to file F8606 at tax time which walks you thru the steps
to do the calculation http://www.irs.gov/pub/irs-pdf/f8606.pdf so you don't have to think (sometimes a dangerous thing

)

TIRAs with deductible contributions are sometimes said to have a basis of 0 since they weren't taxed going in. When thought of in that way, they are similar to taxable invvestments which have a non-zero basis.........only the amount over basis (the gain) is being taxed. When you have TIRAs with a non-deductible component, the basis is non-zero by that amount.

by **grabiner** » Sun Aug 25, 2013 9:15 pm

littlebird wrote:

williamg wrote:Contingent on holding periods and age, you are only taxed on contributions that were not taxed when you made them. All other contributions and gains, both capital and dividend/interest, are not taxable.

I don't believe this can be true. Trad IRAs are taxed on the entire amount *coming out*. Roth IRAs are taxed on the entire amount before *going in*.

There are also non-deductible traditional IRAs, if you are covered by an employer plan and exceed the income limits for the deduction. If you make a non-deductible IRA contribution, you get no tax deduction at the time, but you do not pay tax on the already-taxed portion (prorated if you make a partial withdrawal). The same thing applies to a conversion.

For example, if you have $10,000 in non-deductible contributions, $20,000 in deductible contributions, and $20,000 in gains in your IRA, then 80% of any withdrawal will be taxed. If you convert the whole IRA to a Roth, you pay tax on the $40,000 which was not already taxed; if you convert half of it, you pay tax on $20,000 of the $25,000.

by **ps56k** » Sun Aug 25, 2013 9:16 pm

williamg wrote:Contingent on holding periods and age, you are only taxed on contributions that were not taxed when you made them. All other contributions and gains, both capital and dividend/interest, are not taxable.

Not sure how some of those comments pertain to the basic math calcs used to determine Roth Conversion numbers.

I just ran the Schwab calculator on my 2 examples -
http://www.schwab.com/public/schwab/investing/retirement_and_planning/understanding_iras/ira_calculators/roth_ira_conversion
the only part missing was some kind of time frame... of say..... 10 years to let the calculator project future growth of the 2 scenarios - Trad vs Roth -
BUT, still not sure I understand why the ENTIRE amount is taxed during the "deductible" conversion....

BTW - the $100k "non-deductible" conversion turned out better with Roth after 10 years - but cost $18k in taxes.
As another quick calc - used $200k fully deductible, and it didn't do as well in the Roth and cost a whopping $59k in taxes.

by **DireWolf** » Sun Aug 25, 2013 9:26 pm

While I understand the benefit of a backdoor Roth IRA for a high income earner... it seems to make a portfolio incredibly cluttered.

You open a traditional IRA... contribute $5,500... convert it to a Roth IRA a couple days later. However, for the next fiscal year you have repeat the entire process... open a traditional IRA... contribute $5,500... convert it to a Roth IRA a couple days later... so now you have 2 Roth IRA accounts. If you continue this for 30 years, you will end up with 30 different Roth IRA accounts.

Do I understand this correctly?

by **littlebird** » Sun Aug 25, 2013 9:47 pm

grabiner wrote:

littlebird wrote:

williamg wrote:Contingent on holding periods and age, you are only taxed on contributions that were not taxed when you made them. All other contributions and gains, both capital and dividend/interest, are not taxable.

I don't believe this can be true. Trad IRAs are taxed on the entire amount *coming out*. Roth IRAs are taxed on the entire amount before *going in*.

There are also non-deductible traditional IRAs, if you are covered by an employer plan and exceed the income limits for the deduction. If you make a non-deductible IRA contribution, you get no tax deduction at the time, but you do not pay tax on the already-taxed portion (prorated if you make a partial withdrawal). The same thing applies to a conversion.

For example, if you have $10,000 in non-deductible contributions, $20,000 in deductible contributions, and $20,000 in gains in your IRA, then 80% of any withdrawal will be taxed. If you convert the whole IRA to a Roth, you pay tax on the $40,000 which was not already taxed; if you convert half of it, you pay tax on $20,000 of the $25,000.

Yes, but what williamg said was: "All other contributions and *gains, both capital and dividend/interest, are not taxable*.

by **grabiner** » Sun Aug 25, 2013 10:04 pm

DireWolf wrote:While I understand the benefit of a backdoor Roth IRA for a high income earner... it seems to make a portfolio incredibly cluttered.

You open a traditional IRA... contribute $5,500... convert it to a Roth IRA a couple days later. However, for the next fiscal year you have repeat the entire process... open a traditional IRA... contribute $5,500... convert it to a Roth IRA a couple days later... so now you have 2 Roth IRA accounts. If you continue this for 30 years, you will end up with 30 different Roth IRA accounts.

Do I understand this correctly?

You can make a conversion (or a contribution, for that matter) into an existing account, so you will only have one Roth IRA account.

by **Red Rover** » Mon Aug 26, 2013 12:30 am

grabiner wrote:You can make a conversion (or a contribution, for that matter) into an existing account, so you will only have one Roth IRA account.

I had the same question about additional contributions in subsequent years and have not seen it addressed in any of the information I have found. Are you saying that once a Roth IRA has been established by "back door", subsequent contributions can be made directly to the Roth?

Can anyone cite a source to confirm this?

by **kaneohe** » Mon Aug 26, 2013 12:50 am

Red Rover wrote:

grabiner wrote:You can make a conversion (or a contribution, for that matter) into an existing account, so you will only have one Roth IRA account.

I had the same question about additional contributions in subsequent years and have not seen it addressed in any of the information I have found. Are you saying that once a Roth IRA has been established by "back door", subsequent contributions can be made directly to the Roth?

Can anyone cite a source to confirm this?

not quite sure what you are thinking but I think he is saying that back door conversions can continue into the same Roth account (via the TIRA first as a non-deductible contribution). However if you subsequently become eligible for a Roth contribution and don't need to do the back door conversion, you can make that contribution into the same Roth.

I don't think he is saying that back door Roths (conversions) can go directly to the Roth w/o going thru the TIRA first.

by **grabiner** » Mon Aug 26, 2013 12:52 am

Red Rover wrote:

grabiner wrote:You can make a conversion (or a contribution, for that matter) into an existing account, so you will only have one Roth IRA account.

I had the same question about additional contributions in subsequent years and have not seen it addressed in any of the information I have found. Are you saying that once a Roth IRA has been established by "back door", subsequent contributions can be made directly to the Roth?

As far as a provider such as Vanguard is concerned, there is no distinction between Roth IRAs funded with direct contributions, conversions, or rollovers from employer plans. You just tell Vanguard, "Contribute $5500 from my taxable money-market fund to my Roth IRA in Target Retirement 2045", or "Convert the entire balance of my Traditional IRA to my Roth IRA and invest it in Target Retirement 2045", or "Roll over the Roth 401(k) from my former employer to my Roth IRA and invest it in Target Retirement 2045"; all three will be in the same account.

You have to keep track of the source of transactions for tax purposes. You can withdraw a contribution penalty-free at any time, but if you paid tax on a conversion and withdraw that conversion within five years, there is a 10% penalty on the amount which was taxed at conversion, and if you withdraw earnings and do not meet one of the exceptions such as being 59-1/2, you may owe tax and penalty on the earnings.

by **Bob's not my name** » Mon Aug 26, 2013 4:29 am

Federal tax treatment is discussed above. Illinois tax treatment does not follow federal. Illinois does not tax federal-deductible TIRA contributions, but it diverges from federal treatment in that it exempts all conversions.

Blog Site of ExactCPA.com, the #1 Online Tax CPA with over 190 5-Star Reviews

2015 Tax Filing ? Click below to view our prices & read our reviews...we are the most reviewed tax CPA in the U.S.

Monday, August 26, 2013

Roth IRA conversion - confused on taxing

Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

Re: Roth IRA conversion - confused on taxing

0 comments:

Post a Comment

Contact Form

Popular Posts

.

.