Roth IRA conversion tax question and aggregation rule

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Topic Author
Love4Learning
Posts: 43
Joined: Wed Jan 19, 2022 2:08 pm

Roth IRA conversion tax question and aggregation rule

Post by Love4Learning »

Our income just went over the Roth IRA limit. So husband and I just opened traditional vanguard IRA and contributed $12000 to each account ($6000 for 2021 and $6000 for 2022) for a total of $24000 in both accounts. We put it in the money market, plan to do roth conversation in the next few days before putting it into an index fund to avoid any capital gain prior to the conversion.

I am unclear about the tax impact of this and how to declare this on tax form. Do we need to wait for Vanguard to update some tax form on this contribution to use it for the tax filing for 2021 year? In the past, when we did the roth Ira contribution directly, we didn’t have to declare it when filing tax. If we do the roth IRA conversion the amount for both year 2021 and 2022 now, do we declare it for the 2021 tax year or is that going on next year’s filing since the conversion is done in the year 2022 even though it’s for the 2021 amount?

To make matter more complicated, we recently reviewed my husband’s 401k account from his employer that he left 3 years ago. He has about $300k but they’re charging him administrative about $1000 year on top of the fee in the funds. I compared to my 401k which is same company (Empowerment) but I am charged only about $10 per year in fees and I have 2x his balance. I work for a large company where he works for a very small company so that may explain the high fee.
We’re thinking of rolling over his 401k into an IRA this year. However, I stumble upon roth conversion aggregation rule and it seems that if I convert the Vanguard traditional IRA of $24000 above to roth IRA, then convert the 401k into the IRA then I may be left with a huge tax bill due to this rule. I am unclear about this aggregation rule and seeking some confirmation if I’m reading it correctly. It sounds like the IRS doesn’t care the source of the traditional IRA (pretax or non-deductible) for the roth conversion, so they take a percentage of each to do the roth conversion. So if I convert $24000, then they will consider a high percent of the source from the $300k IRA (convert from 401k) and a small percentage from the $24000 in the vanguard traditional IRA that we just put in. And that will leave us with a huge tax bill because the 300k from the 401k is pre-tax. Is that true?

I appreciate everyone’s help in providing me some explanation to this aggregation rule and any advise for my situation. Thank you!
sycamore
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Re: Roth IRA conversion tax question and aggregation rule

Post by sycamore »

Welcome to the forum Love4Learning!
Love4Learning wrote: Wed Jan 26, 2022 2:02 pm I am unclear about the tax impact of this and how to declare this on tax form. Do we need to wait for Vanguard to update some tax form on this contribution to use it for the tax filing for 2021 year? In the past, when we did the roth Ira contribution directly, we didn’t have to declare it when filing tax. If we do the roth IRA conversion the amount for both year 2021 and 2022 now, do we declare it for the 2021 tax year or is that going on next year’s filing since the conversion is done in the year 2022 even though it’s for the 2021 amount?
You have two sets of contributions: one for tax year 2021, another for tax year 2022.

You'll need to tell your tax software (or tax accountant) that you made contributions $6000 per person for 2021. This information will end up on Form 8606 - one of the form's parts is to document your non-deductible contributions. See https://www.bogleheads.org/wiki/Non-ded ... Cost_basis

You'll do the same for tax year 2022 contributions.

This documentation is needed later on when you perform a Roth Conversion (or if you were to make just a withdrawal).

Others will be along soon to answer your other questions.
Alan S.
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Re: Roth IRA conversion tax question and aggregation rule

Post by Alan S. »

You are correct about the effect of rolling his 401k into his IRA. It would make his 2022 conversion mostly taxable.

However, each spouse's IRAs are treated separately from each other. That means your 12,000 conversion will be tax free since your TIRA will not have an additional balance. But his 401k rollover will disable the strategy for his conversion.

Possible solutions include assessing the length of time before he resigns to take another job with a better 401k, after which he would roll the current 401k into the new 401k, and could then convert with only the gains on his 12k of contributions being taxable. If he plans to stay with current employer and the chance of the current employer reducing their fees by next year are very slim, he could request that his contributions be returned with allocated earnings, and the earnings should be negligible. There is plenty of time for him to request return of the contributions as the deadline for the 2021 contribution return in 10/15/2022, and the 2022 contribution deadline is 10/15/2023. That will provide time to determine if your MAGI for 2021 is too high for any amount of Roth contributions, and if so whether this will still apply for 2022.

Should your joint MAGI permit a 2022 Roth contribution, he could have his 2022 TIRA contribution recharacterized as a Roth contribution up till 10/15/2023. If your 2021 MAGI is in the Roth contribution phase out range, he could do a partial recharacterization of his 2021 TIRA contribution and have the rest returned. These choices disappear if he converts first.
Topic Author
Love4Learning
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Joined: Wed Jan 19, 2022 2:08 pm

Re: Roth IRA conversion tax question and aggregation rule

Post by Love4Learning »

Thank you for your responses.

With current estimates, we're pretty sure we're above the MAGI for Roth contribution for both 2021 and 2022. Salary about $140k each minus $19500 each for pre-tax 401k contribution and max HSA family contribution. When husband left his old job, he started a new job right away. That was about 3 years ago ago and his current employer has a much better 401k with lower fees. We were somewhat ignorant about all of this in this past until I discovered this forum. I think at this point, it looks like our best option maybe just do a rollover of his previous 401k to his current company 401k so that we keep it pre-tax and still take advantage of the Roth conversion in the vanguard traditional IRA without triggering more tax.

I need to read up more about pro and cons of 401k roller to new employer. I always feel there is a catch or some hidden rules that we don't know about that will end up cause a tax disadvantage. Is there any less well known cons of 401k rollover to new employer that we should know about?

Thank you!
placeholder
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Re: Roth IRA conversion tax question and aggregation rule

Post by placeholder »

There's no tax situation rolling a 401k to a new employer the only downside is if the plan is not as good.
Alan S.
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Re: Roth IRA conversion tax question and aggregation rule

Post by Alan S. »

placeholder wrote: Wed Jan 26, 2022 7:12 pm There's no tax situation rolling a 401k to a new employer the only downside is if the plan is not as good.
Right. The former plan is required to provide the necessary detail to the new plan for the new plan to update their accounting. The new plan would maintain the rollover in a "rollover sub account" which usually results in this rollover being eligible for in service distribution if desired.
Topic Author
Love4Learning
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Joined: Wed Jan 19, 2022 2:08 pm

Re: Roth IRA conversion tax question and aggregation rule

Post by Love4Learning »

Thanks for all the responses. Talked to the 401k plan admistrator and it sounds like a simple process to do the direct rollover between old 401k and new 401k. The only thing making us nervous is the market swing up and down on a daily basis. It takes a few days for the rollover so potentially we could lose a lot of money selling on a low day and buying in high a few days later. We asked if there is a money market fund that we can buy into but they say they put it in whatever currently set the contribution which is 100% stock.
Regarding backdoor Roth process was pretty easy also. Put in money market traditional ira, 3 days later I converted to roth Ira, but wasn't fast enough and got 2 cents earnings in money market fund. Probably makes tax a bit more complicated.
Navillus1968
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Re: Roth IRA conversion tax question and aggregation rule

Post by Navillus1968 »

Love4Learning wrote: Mon Feb 07, 2022 10:28 pm Thanks for all the responses. Talked to the 401k plan admistrator and it sounds like a simple process to do the direct rollover between old 401k and new 401k. The only thing making us nervous is the market swing up and down on a daily basis. It takes a few days for the rollover so potentially we could lose a lot of money selling on a low day and buying in high a few days later. We asked if there is a money market fund that we can buy into but they say they put it in whatever currently set the contribution which is 100% stock.
Regarding backdoor Roth process was pretty easy also. Put in money market traditional ira, 3 days later I converted to roth Ira, but wasn't fast enough and got 2 cents earnings in money market fund. Probably makes tax a bit more complicated.
Not really a big deal- IRS doesn't care about pennies <50 cents. https://www.whitecoatinvestor.com/penni ... -roth-ira/
Even if it's over $0.50, you just pay tax on one dollar- 24 cents in the 24% tax rate, etc. Easy-peasy.
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