Roth IRA conversion with underwater assets?

[Closet_Gamer]

Sorry for yet another Roth Conversion thread, but I didn't see an old one that was on point for my specific question:

So, my question:

I have traditional IRAs, but I paid taxes on the principle when it went in because I also have a 401K that I max annually.

I now have funds that are under-water in those IRAs.

Can I designate those assets to be moved in a Roth conversion, and therefore do so tax free because I already paid taxes on the principle and there is no additional income from gain to tax in the transition?

Is this an opportunity to do a Roth Conversion with no tax consequence?

Thanks.

 

[pb4uski]

If I understand you correctly, you are saying that you have a non-deductible IRA where the current balance is less than your cumulative contributions.... if so, then yes, you can convert without any tax cost.

https://www.investopedia.com/articles/pf/12/roth-ira.asp

What if all of a person's IRA savings are composed of nondeductible IRA contributions? If so, they can convert their entire nondeductible IRA to a Roth IRA and will only have to pay taxes on the earnings.

For example, Susan Smith is in a 30% tax bracket this year, and she only has one IRA worth $100,000. The IRA is composed of $90,000 in nondeductible contributions and $10,000 in earnings. If she decides to convert the entire IRA to a Roth, she would only have to pay taxes on the earnings portion ($10,000). At a 30% tax rate, she would owe $3,000 in taxes to convert the entire $100,000 to a Roth.

If Smith had no earnings in this IRA, the entire $100,000 (all nondeductible contributions) could be converted with no tax liability. When earnings are present, the owner must consider if it would be more beneficial to pay the due taxes now, considering that the future benefit would be tax-free.

(emphasis added)

 

[kaneohe]

Your question is a bit ambiguous but if it is as interpreted by pb4uski, then you can do as he says. You may want to consider leaving a few bucks in the TIRA to preserve any remaining basis. Ex: you contributed 20K of non-deductible contributions (and filed 8606 to document). Now it is worth 15K. If you convert 15K minus $1, the conversion is tax-free. The $1 preserves the remaining 5K basis so if somehow you get deductible contributions (from a 401K rollover) or earnings, you will be able to withdraw/convert another 5K tax-free. You need to inquire about min balance requirements on the TIRA to avoid fees/closure.

You also need to have no other TIRAs with deductible contributions for the conversion to be tax free.

This statement is ambiguous to me:
"I now have funds that are under-water in those IRAs."
This could be interpreted to mean : I bought a number of mutual funds and
some of them are under-water. The rest are not under-water. In this case,
you can not selectively choose the tax consequences of converting those particular funds. The tax consequence depends on your total IRA situation.
If overall, you had a gain, there would be a tax even converting just the under-water funds tho it should be relatively small.

Any reason you did not either contribute directly to Roth or convert non-deductible contributions to TIRA immediately to get tax-free growth in Roth
instead of taxable growth in TIRA?

 

[zinger1457]

Would agree there is no tax cost since there are no gains but there are losses. Wouldn't the OP actually have a capital gain loss to deduct on their taxes from the conversion?

 

[kaneohe]

Would agree there is no tax cost since there are no gains but there are losses. Wouldn't the OP actually have a capital gain loss to deduct on their taxes from the conversion?

Prior to the new tax law, you could take a misc deduction (subject to 2% AGI floor). The new tax law eliminated the 2% misc deductions.
https://loopholelewy.com/loopholelewy/articles/Can-I-Deduct-a-Loss-in-My-IRA.htm

 

[N02L84ER]

You did not state that these non-deductible IRAs were your only IRAs. This statement from Kaneohe applies.

You also need to have no other TIRAs with deductible contributions for the conversion to be tax free.

If you had any deductible IRAs and you can roll them into a 401k first, then you can convert the non-deductible IRAs tax free. Otherwise, any conversion will incur taxes on a prorated amount. See tax form 8606.

 

[Closet_Gamer]

Your question is a bit ambiguous but if it is as interpreted by pb4uski, then you can do as he says. You may want to consider leaving a few bucks in the TIRA to preserve any remaining basis. Ex: you contributed 20K of non-deductible contributions (and filed 8606 to document). Now it is worth 15K. If you convert 15K minus $1, the conversion is tax-free. The $1 preserves the remaining 5K basis so if somehow you get deductible contributions (from a 401K rollover) or earnings, you will be able to withdraw/convert another 5K tax-free. You need to inquire about min balance requirements on the TIRA to avoid fees/closure.

You also need to have no other TIRAs with deductible contributions for the conversion to be tax free.

This statement is ambiguous to me:
"I now have funds that are under-water in those IRAs."
This could be interpreted to mean : I bought a number of mutual funds and
some of them are under-water. The rest are not under-water. In this case,
you can not selectively choose the tax consequences of converting those particular funds. The tax consequence depends on your total IRA situation.
If overall, you had a gain, there would be a tax even converting just the under-water funds tho it should be relatively small.

Any reason you did not either contribute directly to Roth or convert non-deductible contributions to TIRA immediately to get tax-free growth in Roth
instead of taxable growth in TIRA?

Thanks -- and to everyone else who replied.

I was talking about cherry-picking out the loss-making funds from a TIRA and moving those. The IRA itself remains above it cost basis. Particularly when you take into account other IRAs I have out there (hadn't even come close to thinking about that!)

I'm in a high income/tax bracket, so straight Roth contributions were never on the table for me.

I've never taken the time to really understood or looked into doing the conversions right when I make the donation...probably a miss and one that I need to dig into.

Thanks again for taking the time to reply.

 

[kaneohe]

It would be useful to learn about F8606 .........https://www.irs.gov/pub/irs-prior/f8606--2019.pdf Presumably you have been filling this out over the years to document your non-deductible contributions?

Pt I leads you thru the steps to calculate the tax on any conversion you do.
It is a relatively straight-forward form but apparently many goof it up on tax software.............so it may be best to understand how it works and to recognize when the answer is right/wrong.

from the bogleheads wiki: https://www.bogleheads.org/wiki/Roth_IRA_conversion
there is a section on non-deductible contributions that may be useful

 

[Closet_Gamer]

It would be useful to learn about F8606 .........https://www.irs.gov/pub/irs-prior/f8606--2019.pdf Presumably you have been filling this out over the years to document your non-deductible contributions?

Pt I leads you thru the steps to calculate the tax on any conversion you do.
It is a relatively straight-forward form but apparently many goof it up on tax software.............so it may be best to understand how it works and to recognize when the answer is right/wrong.

from the bogleheads wiki: https://www.bogleheads.org/wiki/Roth_IRA_conversion
there is a section on non-deductible contributions that may be useful

Thanks!