Tracking the after tax contribuiton to IRA
I want to verify my method of tracking the AFTER TAX contribution to IRA’s once you begin to draw out funds:
You have a SEP valued at ~$307k
You have an IRA valued at ~$53k
Total retirement accounts are $360k.
The SEP is 100% pre tax
Let’s assume the IRA has $36k of AFTER TAX contribution in it.
If you remove, at any time, funds from the SEP or the IRA—forgetting the penalty for now—your money will be taxable based on this equation :
[(Total holdings – after tax amount) / Total Holdings] X funds withdrawn
In this case: [$360-36] / $360 = 90% taxable x any amount withdrawn.
The amount you have contributed after tax must be known by the taxpayer. If, in this example you want to take out 50k (assuming no penalty for now) then you owe tax on .9 x 50 or 45k
This means you have just used up 10% of your after tax accumulated amount so .9 x 36k = $32.4k is left to drawn down at a future time using the percentage method on both the holdings and the after tax amount. This value changes only if you contribute more after tax money to the account OR withdraw more money later. The contribution does not get impacted by market returns.
IS THIS CORRECT?
Permalink Submitted by Alan Spross on Wed, 2010-03-03 20:13
Everything was fine until the second last paragraph.
90% was the correct taxable portion of any distribution. But if you distribute 50k and 45 is taxable, you have used up 5k of your basis. You would have 31k of basis remaining, not 32.4k. The reason your number was wrong here is because you withdrew 50k, which is 13.89% of the total balance. Therefore, your basis was also reduced by 13.89%. 36k original basis less .1389 = 5k used for this distribution and 31k remaining,
The dollar amount of basis is only changed by adding non deductible contributions or taking distributions, but the % of basis in the total account is affected by investment results as well. This means that you do NOT know for sure what your taxable % will be until the end of the year. For example, if you took out 50k in March, but the investments gained for the rest of the year, you would have a higher % taxable on your 8606. If your investments declined, then you would have a lower % taxable on the 8606 because then your basis would be a greater portion of your year end account balance.
Permalink Submitted by [email protected] on Wed, 2010-03-03 20:17
Thanks… I caught the error after my “send button” when I was reviewing my math again.
HOWEVER , is the tax math calculated at a POINT IN TIME or only at YEAR END? Is it a Dec 31 calc based on what you may have withdrawn on Feb 1st?
Permalink Submitted by Alan Spross on Wed, 2010-03-03 20:24
The actual calculation cannot be done until after the year end IRA values are known. If you distribute or convert in Feb., you can only guess at the taxable amount at that time. If you assume no contributions, gains or losses through the end of the year, the %s on that date would be accurate. Otherwise, the taxable amount estimate would be too low if you have gains, or too high if you have losses.
This is even more true for 2010 conversions, since the year end values in 2011 and 2012 will apply to those who defer the income. Year end 2012 is almost 3 years from now and alot can happen in 3 years!
Permalink Submitted by Andrea Cohen on Sun, 2010-06-13 02:08
Alan, your mention of using the year end values as of 2011 and 2012 to determine the portion of taxable income recognized when 2010 conversion includes post tax dollars and income recognition is deferred to 2011/2012 caught my attention a couple months back. I don’t think I’ve seen mention of this anywhere else. We have a situation where income recognition on a 2010 conversion may be deferred and we are holding off rolling over a 401k — based on your comment, the 401k rollover would have to be delayed until 2013 in order not to water down the tax basis of the 2010 conversion. Do I have this right? Is this because of how the Form 8606 works? Thanks very much.
Permalink Submitted by Alan Spross on Sun, 2010-06-13 02:33
Andrea,
Having re read my March post, I find it somewhat misleading with respect to 2010 conversions, and the taxable income deferred to later years.
While the IRS has not yet released the 2010 8606, revisiting the similar conditions in 1998 when 1998 conversions were reported equally over 4 years, the amount of taxable income for 1998 conversions was determined at the end of 1998 only. Assuming that 2010 conversions will follow that same methodology, an 8606 reporting a 2010 conversion would determine the total taxable amount based on adjusted account values at the end of 2010. That taxable income would not be readjusted again in 2011 and 2012, and my prior post did not state this correctly.
If additional conversions were done in 2011 or 2012, the taxable income as adjusted for year end 2011 and 2012 would be added to the taxable income from the 2010 conversion deferred to 2011 and 2012. But if no additional conversions were done in 2011 or 2012, the taxable income determined for the 2010 conversion and deferred to those years would not change again due to total IRA valuation changes or even additional conversions.
I don’t see anything in the TIPRA tax act of 2005 that would change the above, but again the IRS has not yet released the reporting conventions for these 2010 conversions. Once they do, we can confirm that the above assumptions are correct.
Permalink Submitted by Andrea Cohen on Sun, 2010-06-13 03:24
Thanks Alan for clarifying. I appreciate your help.