Hi. Last year when I changed jobs, I rolled my previous employer’s 401k into an IRA. When the end of the year came around, I thought, “Oh I should contribute my $5500 for the 2018 tax year,” and I did, out of my own checking account. Now my tax preparer says that the mix of the pre-tax money in the Rollover IRA with my post-tax contribution money will make my taxes more complicated and I have to keep track of what the pre-tax money is and what the post-tax money is. I don’t know where to start with that since both of those amounts have been growing with the market this year. How do people manage an IRA with both pre-tax and post-tax money? Should I take that $5500 contribution out of my Rollover IRA so as to not mix the two? I’d never heard of this before and didn’t know it might cause problems. I thought I could just stick money in that Rollover IRA as long as I wasn’t taking any out until my retirement.
Regarding the tracking: I have both trad and Roth funds in my 401k. I have two ways to see what in my account is in trad or Roth. First, if I look at my balance details, I can see which amounts of the total balance (including growth) are in trad or Roth. Second, if I look at my my contribution history, I can calculate how much I actually contributed to trad or Roth. (Much addition is involved in initial calculations for this, but if you get a spreadsheet set up for this, it should become pretty rote over time.)
As far as the taxes for this: Can you ask your tax preparer to explain to you what, precisely, is more complicated because of this? Obviously you’ll have to deal with this at retirement wrt what is or is not taxed, but what else do they think you’ll have to do before then besides clearly show this year what was your Roth contribution and what was your rollover? I’m not an expert, but the whole point of IRAs seems to be that they sit there, earning you money… tax free.
I think she may be concerned about me keeping track of the amount taxed and not taxed at retirement. She was also thinking I might have to file an 8606. Does that sound right?
Also, as I keep track of things- do I need to estimate what percentage of my earnings in my stocks/bonds came from the pre-tax rollover or my post-tax contributions?
From my understanding, an 8606 should not be necessary for regular Roth contributions (your $5500) or a traditional-to-traditional rollover. However, if your rollover from your 401k also converted those funds from traditional to Roth, you’ll need an 8606 for sure. Can you check your paperwork to see what the technical details are? (You can check actual paperwork, your online account, or call your fund administrator.)
I know that both @Sunflower and @DeepEllumStash have had to deal with 8606s recently, maybe they will have more input? They certainly have more experience – I’ve never had to do file one.
I don’t know what your legal responsibility is wrt tracking – that’s something you’d have to check out with your tax preparer, or a tax lawyer. Are you interested in doing it just for your own knowledge/just to be safe? If so, we can definitely help you figure that out! (Let me know if you do, this stuff is complicated and I don’t want to write a long confusing post that’s “conversion this” and “spreadsheet that”. )
It’s not a Roth IRA, I rolled into a Traditional one. I make too much to contribute to a Roth. Maybe my tax person is thinking I have a Roth and not a traditional one. I’ll keep looking into this. Thank you again! This is very helpful.
Okay, this makes way more sense! When you said “post tax dollars” I was assuming you meant a Roth contribution.
Another time you have to file an 8606 is when you make non deductible contributions to a traditional IRA. If you make too much to contribute to Roth, then you presumably have to make non deductible contributions - this all makes sense now!
If the rollover and the contributions are the same type, then the growth and the later distributions should all be treated identically. You might need to show for this tax year the difference between the amount you rolled over and the amount you contributed, but those should be easy to find in your account transactions!
Yay I was summoned! I keep meaning to actually update my journal and participate elsewhere but at least I know a little bit about taxes and can stay active in this community by sharing some of this knowledge!
Basically I think your accountant is correct and having taxable and tax-advantaged dollars in a traditional IRA (even if they are two separate IRA accounts) generally makes life difficult. The only way that contributing after-tax dollars to a t-IRA and then converting them to a Roth (backdoor) works well is if you don’t have a balance in your traditional IRAs that is tax.
Depending on how much you rolled over you might want to to consider converting all of that money into a Roth IRA. You will have to pay taxes on all of this money but then it will grow tax free and it will reset your traditional IRA-basis so next year if you contribute to an IRA it will wipe out the pro-rata issues. I would talk with your accountant about whether this makes sense. If you rolled over a very large amount then it might not
That second link was helpful. I really had no idea how complicated this was going to be. I thought I was making good choices by moving the old employer’s 401k into an IRA and figured I’d just add the $5500 or whatever contribution I can make every year until I retire. I even figured that if I move jobs from my current employer, I’d just role that 401k into the aforementioned IRA so I don’t have multiple accounts everywhere. But now I don’t even know what to do. I wish saving for retirement was less complicated! Or taxes. One of the two (or both).
What would I need to factor in for deciding if I have too large of a sum to manage the transfer to a Roth? It was only ~$40k.
ETA: Also, I did the 401k to IRA rollover in December 018, so I wouldn’t be able to roll money to a Roth until 12 months past that time, right?
Yeah, one of my pet peeves is the advice that you should always roll over your 401k. It probably makes sense for the majority of people, either because they aren’t as on top of their finances or because they make more than the income limits for a Roth, but it shouldn’t be universal advice!
In terms of whether or not to convert the full amount to a Roth, I’d consider some of the following:
How many more years are you likely to work?
How many of those years are you going to be above the income limit for contributing money to a Roth IRA?
What is your current tax rate?
With those questions in mind, I would make a spreadsheet in excel and try to figure out if it’s worth it to take a tax hit now. If you expect to work another 10+ years with a high salary, it might make sense to pay the taxes now and start doing the backdoor Roth each year. On the other hand, it’s only ~$5500 a year (+ growth) that you are missing out on and paying taxes now (when you are in a higher bracket) might not make sense just to be able to do a backdoor Roth.
I’m not really a ‘case study’ kind of person but if you post the specifics on MMM or Boggleheads you will probably get a lot of good advice.
Regarding your ETA…a conversion is different from a rollover. If you are doing a backdoor Roth (contributing after-tax money to an traditional IRA and then moving it to a Roth) then you want to convert that money rather than rolling it over so you should be fine. whitecoatinvestor.com has a bunch of articles on how to do a backdoor Roth that I found helpful and I think that MadFientist.com may have some good resources too. Here’s a good place to start https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/
I thought I’d update on what I did: I moved the $5500 contribution and its increase out of the Rollover IRA and put it into a different Traditional IRA. So now the Rollover had pre-tax money and my traditional has post-tax money and it’ll be kept straight until I retire in a billion year. Thank you all!
I was going to suggest this but was not 100% sure it was correct/possible! I ended up recharacterizing my tIRA from last year right at the last minute because it wasn’t beneficial for me to have it in traditional (plus then it will simplify trying to do a Roth ladder). I almost didn’t and just left it in there, but your post reminded me to take a look at it.
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