IRA rollover to RothIRA question

[voidstar]

My wife and I (combined) are slightly past the income limits for RothIRA.

So we've started contributing to tIRA - using the same source that we would have used for the RothIRA (i.e. after-tax income, direct deposited after federal withholding from our employers). [ and we're in a state with no income tax ]

Is there essentially no-reason-to-wait on doing this convertion? For both our IRA's they haven't really gained anything yet (both within 1% of what has been contributed).

Also, after 5 years of having the RothIRA account, we can withdrawal what we've put into the RothIRA (we've both had ours over 10 years). I assume this also applies to converted funds and the brokerages involved will handle tracking that? (i.e. if our rIRAs happened to have gained 20% over the past year, we'd be taxed on that during a conversion - and somehow their systems will track that we've had a $7000 "cash contribution" {effectively}?)


Vanguard has a nice "Convert to Roth IRA" button, but I wanted to ask first since I'm getting the impression the Vanguard site is assuming it is all pre-tax source? There was a reference to a "Show by Source" link for Vanguard, but I wasn't able to find it. I've read about the Form 8606 reporting, but that's in us for tax reporting. How does Vanguard know this is after-tax funded? And will it be a 1:1 share-per-share conversion (on what we've already allocated the tIRA to), or do they "sell everything" and put into their default account, and we have to do the allocations again after the conversion? I'll call Vanguard when we get a chance during business hours, but was curious on others experience with the process.

And for that matter, if it's all after-taxed funded, does it make any difference to do the conversion now or in a few years when we're ready for retirement (3-5 years or so)? (aside from the risk that the feds elect to disallow conversions; in which case, just do it annually?)

 

[SecondCor521]

My wife and I (combined) are slightly past the income limits for RothIRA.

So we've started contributing to tIRA - using the same source that we would have used for the RothIRA (i.e. after-tax income, direct deposited after federal withholding from our employers). [ and we're in a state with no income tax ]

[1] Is there essentially no-reason-to-wait on doing this convertion? For both our IRA's they haven't really gained anything yet (both within 1% of what has been contributed).

[2] Also, after 5 years of having the RothIRA account, we can withdrawal what we've put into the RothIRA (we've both had ours over 10 years). [3] I assume this also applies to converted funds and the brokerages involved will handle tracking that? [4] (i.e. if our rIRAs happened to have gained 20% over the past year, we'd be taxed on that during a conversion - and somehow their systems will track that we've had a $7000 "cash contribution" {effectively}?)


[5] Vanguard has a nice "Convert to Roth IRA" button, but I wanted to ask first since I'm getting the impression the Vanguard site is assuming it is all pre-tax source? There was a reference to a "Show by Source" link for Vanguard, but I wasn't able to find it. I've read about the Form 8606 reporting, but that's in us for tax reporting. [6] How does Vanguard know this is after-tax funded? [7] And will it be a 1:1 share-per-share conversion (on what we've already allocated the tIRA to), or do they "sell everything" and put into their default account, and we have to do the allocations again after the conversion? I'll call Vanguard when we get a chance during business hours, but was curious on others experience with the process.

[8] And for that matter, if it's all after-taxed funded, does it make any difference to do the conversion now or in a few years when we're ready for retirement (3-5 years or so)? [9] (aside from the risk that the feds elect to disallow conversions; in which case, just do it annually?)

[Numbers added for reference]

1. There is no reason to wait to do the conversion. But you can wait if you want to. Also, see the comments about "pro rata" in the last paragraph below under A9.

2. The IRS deems Roth IRA withdrawals to come first from contributions, second from conversions, and third from earnings. You can withdraw Roth contributions at any time with no taxes or penalties.

3. Not exactly. You can withdraw Roth conversions (what you're talking about now) after five tax years have elapsed tax and penalty free. Conversions are treated as though made on 1/1 of the year in which the conversion occurs, and are tax and penalty free five years after that date. So a conversion today would have the five year clock start 1/1/2024 and end 1/1/2029.

Also, the brokerages do not track this for you. You're required to keep track of your contributions and conversion history via your own tax records.

4. They'll report a Roth conversion of $7,000. And it's a conversion, not a contribution. Conversions are handled differently than contributions - see #2 and #3 above.

5. Vanguard doesn't care the amount of the conversion that is pre-tax or post-tax. That's for you to keep track of via your Form 5498s, Form 1099s sent to you by your IRA custodians and Form 8606s prepared by you and submitted with your tax return.

6. They don't care. See question 5.

7. You can convert in-kind, which means you can move, say, 100 shares of IBM from your trad IRA to your Roth IRA. Or you can sell, move cash, then re-buy or buy something else.

8. See question 1. Also, see the comments about "pro rata" in the last paragraph below under A9.

9. Highly unlikely the feds will disallow conversions. Conversions are typically taxed as ordinary income, and thus raise tax revenues.

Something you didn't mention in your questions - you're talking about non-deductible IRA contributions. Those should be reported on Form 8606 Part I in the year of contribution. Roth conversions are reported on Form 86066 Part II in the year of conversion. If you have other deductible traditional IRA contributions from before, you'll find yourself dealing with the calculations in Part I which is commonly called the "pro rata" rule because you get to pro rate the two types of contributions when doing Roth conversions. This may impact when you want to do the Roth conversions; waiting will generally increase the balance in your traditional IRA and affect the pro rata ratio.

 

[NgineER]

White Coat Investor has a step-by-step tutorial for backdoor Roth IRA. The backdoor Roth is for people who make too much to do regular Roth contributions. This would apply to you also. I've followed these steps for 2022, 2023 and 2024.

https://www.whitecoatinvestor.com/how-to-do-a-backdoor-roth-ira-with-vanguard/

 

[karen1972]

SecondCor521 covered most of it.

Assuming you were over the income cap for traditional IRA deduction, all your contributions went in after tax, so if you convert it all today, you only owe taxes on whatever the gain is and that is resolved at tax time when you file as I wouldn't worry if its only 1%.

Before 2010, there use to be an income cap on conversions, so anyone making over a certain amount couldn't do any type of conversion. The law changing that was actually passed in 2006, so I remember contributing in 2006-2010, thinking I'd just pay the taxes and do the full conversion.. well in 2010 the market was still way down and I had contributed $18,000 but the value of the account was only $17,648, thus I converted 100% of it with zero additional taxes owed.

With the market dip yesterday, are you even on the plus side? If not like me you could potentially convert today with zero additional taxed owed and be done.

Then going forward you should consider back door roths.. converting the money immediately before it has any time to have any gains.

 

[NgineER]

SecondCor521 covered most of it.

Assuming you were over the income cap for traditional IRA deduction, all your contributions went in after tax, so if you convert it all today, you only owe taxes on whatever the gain is and that is resolved at tax time when you file as I wouldn't worry if its only 1%.

Before 2010, there use to be an income cap on conversions, so anyone making over a certain amount couldn't do any type of conversion. The law changing that was actually passed in 2006, so I remember contributing in 2006-2010, thinking I'd just pay the taxes and do the full conversion.. well in 2010 the market was still way down and I had contributed $18,000 but the value of the account was only $17,648, thus I converted 100% of it with zero additional taxes owed.

With the market dip yesterday, are you even on the plus side? If not like me you could potentially convert today with zero additional taxed owed and be done.

Then going forward you should consider back door roths.. converting the money immediately before it has any time to have any gains.

Karen is right on - convert everything as soon as you can. Vanguard requires one day inbetween contribution and conversion. There is probably a reason for it, but I don't know what it is.

 

[voidstar]

Thanks all, conversions in progress!

There was some weird stuff about the accounts couldn't currently be 100% converted (I suspect having to deal with partial shares and also recently "loaned shares" has become a thing - I had to ask about a new nebulous position that appeared in my account, and Fidelity said it was a holding area to account for loaned out shares). Anyhow, I manually just specified whole shares for everything it let me, then I'll sell anything left and convert the cash remaining next week.