Roth Conversion Tax Question

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austriak
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Roth Conversion Tax Question

Post by austriak »

I recently converted a small amount of my traditional IRA to a new Roth, all with Vanguard. When I look at the Roth, I can see my cost basis and short and long term capital gains. I wanted to verify which amounts I would be taxed on. I would think just the cost basis because the whole point of a Roth is to not pay taxes on the growth. However, when I google it, lots of sites make it sound like you are taxed on all of it.

Anyone can help clarify? Thanks.
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RickBoglehead
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Re: Roth Conversion Tax Question

Post by RickBoglehead »

When you put money in your traditional IRA, you were taxed on none of it. When you converted to a Roth, you are taxed on all of the conversion as ordinary income.

The savings with a Roth are realized when you go to withdraw the funds, which can be totally tax free based on age.

Why did you convert anything if you didn't understand this? What was the purpose of converting?
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austriak
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Re: Roth Conversion Tax Question

Post by austriak »

I get how a Roth works when you do normal contributions and when you pull out funds in retirement. I would have thought that you would just pay taxes on the cost basis when converting since that is what you would have been taxed on if you had contributed originally to a Roth rather than traditional. Roth conversion doesn’t seem as great if you are taxed on the growth at conversion which doesn’t happen if it was originally contributed to a Roth.
MrJedi
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Re: Roth Conversion Tax Question

Post by MrJedi »

You need to consider your tax basis of the IRA contribution and conversion. Brokers do not track that for you. I would essentially ignore cost basis, capital gains, etc. in the IRA accounts, they do not factor into your taxes.
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RickBoglehead
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Re: Roth Conversion Tax Question

Post by RickBoglehead »

austriak wrote: Thu Jul 29, 2021 7:20 am I get how a Roth works when you do normal contributions and when you pull out funds in retirement. I would have thought that you would just pay taxes on the cost basis when converting since that is what you would have been taxed on if you had contributed originally to a Roth rather than traditional. Roth conversion doesn’t seem as great if you are taxed on the growth at conversion which doesn’t happen if it was originally contributed to a Roth.
That's why understanding before you convert is crucial.
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livesoft
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Re: Roth Conversion Tax Question

Post by livesoft »

austriak wrote: Thu Jul 29, 2021 7:20 am I get how a Roth works when you do normal contributions and when you pull out funds in retirement. I would have thought that you would just pay taxes on the cost basis when converting since that is what you would have been taxed on if you had contributed originally to a Roth rather than traditional. Roth conversion doesn’t seem as great if you are taxed on the growth at conversion which doesn’t happen if it was originally contributed to a Roth.
A Roth conversion is like a a withdrawal from a traditional IRA and then putting the money in a Roth IRA. Simple as that. But note that withdrawals from a traditional IRA do not have to be taxed under some circumstances. For instance, any nondeductible traditional IRA contributions are not taxed. Also if one is in the 0% tax bracket (including the traditional IRA withdrawal), then one pays no tax on the traditional IRA withdrawal that then gets put into a Roth IRA (i.e. gets converted).

There are some complications with nondeductible traditional IRA contributions that are addressed on IRS Form 8606.
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Statistical
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Re: Roth Conversion Tax Question

Post by Statistical »

austriak wrote: Thu Jul 29, 2021 6:58 am I recently converted a small amount of my traditional IRA to a new Roth, all with Vanguard. When I look at the Roth, I can see my cost basis and short and long term capital gains. I wanted to verify which amounts I would be taxed on. I would think just the cost basis because the whole point of a Roth is to not pay taxes on the growth. However, when I google it, lots of sites make it sound like you are taxed on all of it.

Anyone can help clarify? Thanks.
Assuming the tIRA was 100% pre-tax funds (likely) then you are taxed on the full amount of the conversion. If you converted $10,000. That is $10,000 in regular income added to any other income and taxed at regular income rates.

There is nothing on the Roth balances which will show you how much you are taxed the tax is on the conversion itself.

Now if some of the tIRA was after-tax (non-deductible) contributions then the pro-rata rule applies so you would pay taxes on the portion of the conversion that came from pre-tax funds but in most circumstances this is unlikely.
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CAsage
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Re: Roth Conversion Tax Question

Post by CAsage »

austriak wrote: Thu Jul 29, 2021 6:58 am ... I would think just the cost basis because the whole point of a Roth is to not pay taxes on the growth. However, when I google it, lots of sites make it sound like you are taxed on all of it.
The tax free growth in a Roth IRA (fabulous feature) only occurs AFTER the money is placed in the Roth. One cannot take gains and then "hide" them by moving them to a Roth. Many people do a "backdoor Roth conversion) by contributing to an IRA and them immediately converting it to a Roth. But you really need to understand the details and rules on each kind of account.
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Lee_WSP
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Re: Roth Conversion Tax Question

Post by Lee_WSP »

You will be taxed on the amount converted.

You should receive a 1099 with that amount.

You can see for yourself by filling out form 8606. You'll want to take a look at it as you'll need to fill it out eventually.
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FiveK
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Re: Roth Conversion Tax Question

Post by FiveK »

austriak wrote: Thu Jul 29, 2021 7:20 am I would have thought that you would just pay taxes on the cost basis when converting since that is what you would have been taxed on if you had contributed originally to a Roth rather than traditional. Roth conversion doesn’t seem as great if you are taxed on the growth at conversion which doesn’t happen if it was originally contributed to a Roth.
The commutative property of multiplication says that for equal tax rates it doesn't matter where the growth occurs. See the Simplest situation discussion.
earlyout
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Re: Roth Conversion Tax Question

Post by earlyout »

If you ignore the complications caused by nondeductible contributions to the IRA, the entire amount taken from a traditional IRA , whether it is for a Roth conversion, to satisfy a required minimum distribution or because you need cash, is taxed as regular income. There is no distinction between your contributions to the IRA and the investment gains that occurred within the IRA, any distribution is taxed as regular income.
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celia
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Re: Roth Conversion Tax Question

Post by celia »

We know that the assets were taxed BEFORE they went into a Roth and every dollar WITHDRAWN from tax-deferred will be taxed as ordinary income. So you will only be taxed on the amount you withdrew from the tIRA (including any amount that was withheld for taxes).

Within the Roth and tax-deferred accounts, shares can be bought and sold as much as you want without any tax implications or IRS reporting. But when you sell an asset and buy something else, the "cost basis" is your new purchase price for that asset, which has nothing to do with how much you contributed or converted into the account! In retirement accounts (like IRAs), the cost basis just helps you see how much growth you've had so far, since you bought that asset.
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