Roth Conversion into existing Roth IRA account - accounting

[a60dan]

I started this thread so as not to convolute the others on the 5 year rule.

I didn't see this addressed in the other threads.

Please re-direct me if it was covered elsewhere and I missed it.

I don't want to open more Roth accounts mainly because the rebalancing becomes even more difficult given the number of accounts we already have :-(

If I convert into the existing Roth IRA, will I be able to tell as I withdraw the funds whether the distribution will be "qualified" or "not qualified"? I think I read that the "custodian" makes that call and issues the appropriate tax form that implements the 5 year rule.

While my intent is to leave the converted funds and earnings in for the full 5 years, I'm certain that I will need to take distributions from the pre-conversion balance during the next 5 years.

I've already been accused of being obsessed with taxes by my bride and don't want to make it worse

While it's easier to make a new account, I'd like to have the least amount of pain over time with:
- rebalancing over the fewest number of accounts
- determining BEFORE income tax filing time what the ramifications are

Real world experience is greatly appreciated as this is my first conversion.

Last day of w*rk is 12/31/2021!

 

[Retireby45ish]

You really buried the lede with that last line! Congrats!!

Sorry can’t help answer the question though I am curious what the answer is myself.

 

[SecondCor521]

There is no need to have separate Roth accounts. What you do need to keep track of is your contributions, and your conversions by year.

Roth conversions are reported on your tax return on Form 8606 Part II. You should file this form with your 2021 tax return if you do a Roth conversion this year. And of course, in any subsequent year. Make sure you use the proper tax year as the form varies (slightly) from year to year. Your custodian will send you a Form 1099-R with the total dollar amount of your conversion in box 1.

Regardless of what happens inside any of your Roth accounts, the IRS treats them as one big Roth account and it is a black box as far as they are concerned. Your withdrawals from your Roth will be deemed to be contribution dollars first, then conversion dollars, oldest first, then earnings last.

The custodian will not keep track of this for you. If you withdraw from a Roth before age 59.5, they will send you a 1099-R also and will likely code it in box 7 as a "1" which means a before 59.5 withdrawal, no known exception. If you do qualify for an exception, then you will probably need to fill out Form 5329.

Roth withdrawals (aka distributions) are reported on your tax return on Form 8606 Part III. You'll need to know your contribution and conversion history (as mentioned above) in order to complete this section properly.

 

[Animorph]

I created a ton of Roth accounts at Fidelity for another reason, which no longer applies these days. It's easy enough to rebalance the total Roth balance using a spreadsheet. I
don't bother keeping each account at the same AA, so whichever account (or accounts) has enough of the fund I want to sell rebalances all of them. The same is true for taxes. All accounts of one person are treated as one account. Quicken or something similar tracks all the accounts without a big hassle.

The only big hassle I've seen (still to come) is if I want to combine separate Roth accounts into a few combined accounts. So far Fido wants me to send in a paper form to consolidate Roth accounts, though I haven't asked about phoning them. I've been waiting for an online form for years now.

If you can get by with just one account per person that might be the easiest way to go.

 

[Retireby45ish]

There is no need to have separate Roth accounts. What you do need to keep track of is your contributions, and your conversions by year.

Roth conversions are reported on your tax return on Form 8606 Part II. You should file this form with your 2021 tax return if you do a Roth conversion this year. And of course, in any subsequent year. Make sure you use the proper tax year as the form varies (slightly) from year to year. Your custodian will send you a Form 1099-R with the total dollar amount of your conversion in box 1.

Regardless of what happens inside any of your Roth accounts, the IRS treats them as one big Roth account and it is a black box as far as they are concerned. Your withdrawals from your Roth will be deemed to be contribution dollars first, then conversion dollars, oldest first, then earnings last.

The custodian will not keep track of this for you. If you withdraw from a Roth before age 59.5, they will send you a 1099-R also and will likely code it in box 7 as a "1" which means a before 59.5 withdrawal, no known exception. If you do qualify for an exception, then you will probably need to fill out Form 5329.

Roth withdrawals (aka distributions) are reported on your tax return on Form 8606 Part III. You'll need to know your contribution and conversion history (as mentioned above) in order to complete this section properly.

Once you wait 5 years past the date of the last conversion though you can just take all the $$ out tax free right? You don’t need the breakdown of conversion vs earnings etc.

Just checking to make sure I don’t make a silly mistake.

 

[SecondCor521]

Once you wait 5 years past the date of the last conversion though you can just take all the $$ out tax free right? You don’t need the breakdown of conversion vs earnings etc.

Just checking to make sure I don’t make a silly mistake.

As long as you are over 59.5, yes. You'd need the age of your oldest Roth to be at least 5 years old, but in the scenario you describe it sounds like that would be the case.

If you're under 59.5, no. I think then there would be tax and penalty on whatever portion of the distribution was attributable to earnings.

 

[NgineER]

I created a ton of Roth accounts at Fidelity for another reason, which no longer applies these days. It's easy enough to rebalance the total Roth balance using a spreadsheet. I
don't bother keeping each account at the same AA, so whichever account (or accounts) has enough of the fund I want to sell rebalances all of them. The same is true for taxes. All accounts of one person are treated as one account. Quicken or something similar tracks all the accounts without a big hassle.

The only big hassle I've seen (still to come) is if I want to combine separate Roth accounts into a few combined accounts. So far Fido wants me to send in a paper form to consolidate Roth accounts, though I haven't asked about phoning them. I've been waiting for an online form for years now.

If you can get by with just one account per person that might be the easiest way to go.

+1 Just rebalance in one account that is large enough to handle the swings. No need to rebalance in all accounts.

 

[a60dan]

Thanks for the succinct reply.

Good point that I will have the records of conversion amounts in tax return records.

Regarding the earnings from the conversions vs the earnings from the money that is past the 5 year rule, I can’t wrap my head around how that would be traceable and accounted for.

That’s the only reason I can think of to convert into separate accounts.

 

[SecondCor521]

Thanks for the succinct reply.

Good point that I will have the records of conversion amounts in tax return records.

Regarding the earnings from the conversions vs the earnings from the money that is past the 5 year rule, I can’t wrap my head around how that would be traceable and accounted for.

That’s the only reason I can think of to convert into separate accounts.

Earnings, regardless of where they came from, go into the third bucket and are withdrawn last (after contributions and conversions) by IRS rule.

The IRS and you can always know how much is in the earnings bucket as follows:

Earnings = Total Roth balance - total contribution dollars - total conversion dollars

You and the IRS know the three values on the right hand side of the above equation and can do the math to determine earnings.

What this means is that if you converted an investment worth $5K a number of years ago and it grew into $9K, the $4K in growth is in the earnings bucket. It does not stay with and is not associated with the $5K conversion dollar amount.

Suppose you also earlier had made a $3K contribution to your Roth, and that amount had grown to $7K. Same thing here - the additional growth ends up in the earnings bucket and does not stay with or remain associated with the initial contribution dollars.
The equation would look like this:

Earnings = ($9K + $7K) - $3K - $5K = $8K earnings

Again, the IRS doesn't care at all what happens inside the Roth account. They only care about total contributions and total conversions. Total contributions get reported to them on Form 5498s, and total conversions get reported to them on Form 1099-Rs.

Said another way, the fact that your Roth conversions probably grow over time doesn't allow you to withdraw any additional amount as conversions. You only get to withdraw as conversions whatever the dollar value of the conversion amount was when you made the conversion. And the same holds true for contributions.

 

[Time2]

This form 8606 stuff got my concerned I did my first Roth Conversion last year and also started doing my own taxes using Turbo Tax.

So I pulled out last years tax forms and yep, there it was the glorious 8606 with part 2 completed.

Gee, I can hardly wait to do this years taxes.

 

[SecondCor521]

This form 8606 stuff got my concerned I did my first Roth Conversion last year and also started doing my own taxes using Turbo Tax.

So I pulled out last years tax forms and yep, there it was the glorious 8606 with part 2 completed.

Gee, I can hardly wait to do this years taxes.

If you're just doing another Roth conversion or conversion(s), it's pretty easy. There will just be another Form 8606 with whatever you converted this year on the equivalent two lines.

Remember you'll want to save all of your Form 8606s if you plan to withdraw from your Roths before 59.5 so you can complete Part III properly.

 

[a60dan]

Earnings, regardless of where they came from, go into the third bucket and are withdrawn last (after contributions and conversions) by IRS rule.

The IRS and you can always know how much is in the earnings bucket as follows:

Earnings = Total Roth balance - total contribution dollars - total conversion dollars

You and the IRS know the three values on the right hand side of the above equation and can do the math to determine earnings.

What this means is that if you converted an investment worth $5K a number of years ago and it grew into $9K, the $4K in growth is in the earnings bucket. It does not stay with and is not associated with the $5K conversion dollar amount.

Suppose you also earlier had made a $3K contribution to your Roth, and that amount had grown to $7K. Same thing here - the additional growth ends up in the earnings bucket and does not stay with or remain associated with the initial contribution dollars.
The equation would look like this:

Earnings = ($9K + $7K) - $3K - $5K = $8K earnings

Again, the IRS doesn't care at all what happens inside the Roth account. They only care about total contributions and total conversions. Total contributions get reported to them on Form 5498s, and total conversions get reported to them on Form 1099-Rs.

Said another way, the fact that your Roth conversions probably grow over time doesn't allow you to withdraw any additional amount as conversions. You only get to withdraw as conversions whatever the dollar value of the conversion amount was when you made the conversion. And the same holds true for contributions.

This is extremely helpful.

If I understood, as long as I’m within 5 years of the most recent conversion, don’t take anything from the earnings bucket and I have nothing to worry about.

I’m going to see if I can run a contribution report on Schwab and see what the earnings bucket looks like.

Are you by chance a tax accountant? [emoji3]

 

[SecondCor521]

This is extremely helpful.

If I understood, as long as I’m within 5 years of the most recent conversion, don’t take anything from the earnings bucket and I have nothing to worry about.

I’m going to see if I can run a contribution report on Schwab and see what the earnings bucket looks like.

Are you by chance a tax accountant? [emoji3]

As long as your current year's withdrawals are less than the sum of your remaining contributions and your seasoned conversions then I think you are OK. That's not necessarily the same as your second paragraph above; I could give you counterexamples.

I'm not a tax accountant. I have an MBA so I've passed some accounting and finance classes. I have encountered most of these scenarios either in my own taxes or in the taxes of my family members. Because I also just enjoy this stuff, I also volunteer with AARP Foundation Tax Aide.

 

[a60dan]

As long as your current year's withdrawals are less than the sum of your remaining contributions and your seasoned conversions then I think you are OK. That's not necessarily the same as your second paragraph above; I could give you counterexamples.

I'm not a tax accountant. I have an MBA so I've passed some accounting and finance classes. I have encountered most of these scenarios either in my own taxes or in the taxes of my family members. Because I also just enjoy this stuff, I also volunteer with AARP Foundation Tax Aide.

I found this app on irs.gov.

It doesn’t even ask about conversions:

https://www.irs.gov/help/ita/is-the-distribution-from-my-roth-account-taxable

 

[cathy63]

I found this app on irs.gov.

It doesn’t even ask about conversions:

https://www.irs.gov/help/ita/is-the-distribution-from-my-roth-account-taxable

Yes it does. You will only see the conversion question if you say you are under 59.5 or have had a Roth account for less than 5 years. Then if you then answer the conversion question Yes, you get this:

Answers to Your Questions About Income

Is the distribution from my Roth account taxable?

The Roth IRA distribution is not taxable.
The distribution is not more than the basis (previously taxed amounts).

Report your distribution by entering the total distribution amount on the IRA distributions line "a" of your tax return. Enter zero on line "b".

You must complete Form 8606, Nondeductible IRAs.

Additional Tax on Early Distributions
Since you were under age 59 1/2 at the time of the distribution and a conversion was done within the 5-year period, you may be subject to the additional tax on early distributions.

To determine if you owe this additional tax, click on the "Do I Meet an Exception to the Additional Tax on an Early Distribution from an IRA or Retirement Plan?" link below to find out.

 

[CRLLS]

Please, for the sake of your heirs, combine the Roths into one. Simplify finances wherever possible. They will thank you for it.

 

[skyking1]

I think we might make a separate Roth for DW's conversions. She and I have Roths from long ago that we could withdraw from any time after we retire.
She has the only tIRAs, and we could just leave that bucket alone for 5 years after the last conversion.
No heirs to worry about here .

 

[NgineER]

Please, for the sake of your heirs, combine the Roths into one. Simplify finances wherever possible. They will thank you for it.

Not necessary to do while under 59.5, after that it should be done. Makes it easier down the road.

 

[mrfeh]

I can't answer the original question, but I would opt for a new account if there is any chance that contributions need to be treated differently.

I'll take the hassle of another account over trying to track components of a single account.

 

[SecondCor521]

I can't answer the original question, but I would opt for a new account if there is any chance that contributions need to be treated differently.

I'll take the hassle of another account over trying to track components of a single account.

I understand the motivation behind the idea, but it still doesn't fix the problem you mention.

For example, if I have two Roths, one with a $3K contribution that grew to $7K over the years, and a second Roth which only contains a $5K conversion from a few years ago that grew to $6K, then I have the following situation:

Roth 1: $3K contributions, $4K earnings
Roth 2: $5K conversion, $1K earnings

When I go to withdraw, the IRS considers it in the following order *regardless of which account I take the withdrawal from*: $3K contributions, $5K conversion, $5K earnings.

So even with multiple Roths, you still are likely to have mixtures of the different types of dollars in them.

It actually gets a bit worse, because if it were 2008, the second Roth account's conversion could have lost money, so you might have what you could consider negative earnings even though overall your Roth is up overall. Something like:

Roth 1: $3K contributions, $3K earnings
Roth 2: $5K conversion, -$1K earnings

So you would have $3K contributions, $5K conversions, and $2K earnings. But having separate Roths here makes it a bit confusing as to how to treat negative earnings in Roth 2.

Again, the IRS considers all of your Roth IRAs as one Roth account (no matter how many you have), and the order that your withdrawals occur in are deemed by IRS rules to be contributions, then conversions, then earnings *regardless of which account you take the withdrawals from*.

 

[a60dan]

I recently reviewed my tax returns to determine my current “basis” for my single Roth IRA.

Much to my dismay I learned that in 2019 the basis data in Turbotax did not transfer from 2018.

I’m paying more attention on my 2021 return and correcting the basis to reflect all contributions.

I also re-learned that Schwab can’t tell me beyond 10 years what the contributions were or when I opened the account *. So much for saving tax supporting documents for only 3 years.

Anyway, I noticed the TurboTax worksheets track 5 years of conversions each year. If I pay more attention to that worksheet going forward, I think it will help me estimate the damage I might do [emoji2]