Let`s say 80% of the funds in three of your IRAs are pre-taxed, while 20% have already been taxed. Let`s say you convert 20% of your money into a Roth IRA. You might be tempted to pretend that what you are transferring is the 20% that has already been taxed, and therefore you don`t owe any new taxes. Unfortunately, this is not the case – due to the pro-advice rule, 80% of all conversions are subject to new taxes, regardless of the account the money comes from. Hi David, I have $1,000 before taxes in my rollover IRA. I don`t have any other traditional IRA money now. To get around the pro-rata rules (“remove” the pre-tax money in the traditional IRA, then contribute the after-tax money to the traditional IRA and finally convert it to Roth IRA), do you recommend an advance payment of that $1,000? The penalty for that $1,000 is perfectly acceptable, and $1,000 will not increase my bracket limit. Is there another risk I`m missing? Enjoy it! Finally, the SEP IRA values and THE SIMPLE IRA VALUES are included in the definition of all IRAs. Although these types of accounts are sponsored by companies, they must be included in the pro-rata calculation. However, an inherited IRA is not used in the pro-rata formula2. Now, imagine ben, who isn`t aware of the pro-rated complications described above, brings back the $310,000 of his 401(k) and traditional IRA on December 1, 2020. Specifically, Ben can transfer the entire account balance minus after-tax contributions for a total of $350,000 to $40,000 = $310,000 of his traditional IRA, which is the sum of the pre-tax funds accumulated in the account.
Although such a distribution is normally treated as if it were a ratifiable amount of pre-tax and after-tax dollars, since the rollover target is Ben`s 401(k) and after-tax dollars are not allowed to be paid into such accounts, the total amount of $310,000 is treated as consisting of pre-tax dollars! Step 5 sets out an exception for the prorated deviation when converting the IRA to 401k retirewithgrace.com/resources/whitepapers/calculating-the-pro-rata-rule-in-5-easy-steps/ The pro-rata rule is something that must be actively considered when planning for retirement. Other important things to keep in mind are: Taxpayers should track after-tax balances on IRA accounts on IRS Form 8606. The form must be completed with the tax return each year the taxpayer makes an after-tax contribution (or is transferred after-tax funds from an employer plan to their IRA), and it must be filed each year following that a distribution is deducted from the IRA. The form uses prorated calculation to determine the amount of the taxable distribution. Example 1. Karen has a traditional IRA with brokerage A. worth $120,000 This traditional IRA includes non-deductible contributions of $30,000 (after-tax contributions, “cost base”). She also has a traditional IRA of $50,000 with Brokerage B, which she transferred directly from a 401(k) eligible pension plan she participated in. The traditional rollover IRA consists exclusively of pre-taxed money. To take advantage of the current federal tax rate, Karen will convert $30,000 of her IRA into a Roth IRA using Brokerage A on December 15, 2020.
She believes that her conversion will be completely tax-free. But the “pro-tata” rule prevents Karen from simply “choosing” post-taxed dollars for a tax-free conversion. Once these pre-tax funds are removed from the IRA, only the $24,000 that is not deductible remains in the IRA. Thus, if the IRA is free of any pre-tax money, the conversion of non-deductible funds into Roth IRA will not be negatively affected by the IRS pro rata rule. We can initiate a tax-free transfer of non-deductible funds to the Roth IRA, setting the IRA balance at zero. Converting an IRA to Roth IRA is a simple process. There are no income restrictions. Non-deductible ira contributions are after-tax money and therefore not taxable when you convert. All deductible contributions to the IRA plus income from all IRA accounts represent pre-tax money. How the IRS charges after-tax and input tax funds in an IRA when the taxpayer makes a partial Roth conversion is called the pro-rata rule1. Excellent questions and points were raised by Jonathon. Thank you for contributing to the interview.
First of all, it`s important to remember that many people don`t have a 401(k) to transfer IRA funds. If you have a 401(k) and your plan allows for a 401(k) rollover, this will help minimize the impact of the pro-rata rule (as you indicated). Many people end up with an IRA due to the introduction of a 401(k) plan due to termination of employment and may no longer have a 401(k) plan. With regard to “moving to an immediate pension”, I do not have a concrete answer. However, it goes without saying that it is still an IRA, although it is an immediate annuity and is included in the proportional rule. If you find information that says otherwise, please post here in the comments. If most (or all) of your contributions have already been taxed, the pro-rata rule is not that important. But if you haven`t paid much (or not at all) tax on all of your savings, which is often the case, you should expect a higher tax bill. I have a question about pro-rata and pensions. I recently gathered all my IRAs into a 401k solo to avoid doing my Roth IRA conversion through the back door every year (I`m self-employed). .
