My Roth Conversion $20,000 Tax Mistake – Anyway Out? Sorry, Long Post

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This topic contains 3 replies, has 2 voices, and was last updated by  Alan S. 2 months ago.

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  • #3208

    cjmassey
    Participant

    This was originally posted in another part of this forum but it was suggested to be moved here.

    In late 2016, I was contacted by a representative of Fidelity, my company 401 K provider, to see if I was interested in rolling my IRA from Vanguard to a Rollover IRA with them. The purpose of this was to allow me to perform a Roth conversion without any tax consequences. This would be done by rolling only the taxable funds in the new Rollover IRA into my 401K , leaving my basis of $59K that came from non deductable IRA contributions over the years (IRS Form 8606 Line 14, ). This remaining basis in the Fidelity Rollover IRA could then be converted to a Roth IRA. When I filed my taxes for 2018 and filled out the form 8606, on Line 6 where it asks for the value of all my traditional IRAs as of 12/31/18, I would then be able to put in $0, since all my IRA funds had been rolled over into my 401K. This would take the pro rata rule out of play and the entire $59K conversion would not be taxable.

    Roll taxable IRA Funds to 401K, Convert Non Taxable Basis to Roth

    This sounded good to me, so in late 2016 and early 2017 I rolled my IRA from Vanguard to a Rollover IRA at Fidelity. On 1/12/2018, we started the rollover of all my taxable funds in My Fidelity Rollover IRA into my company 401K (also with Fidelity) to isolate my basis of $59K. They then converted those funds to a Roth IRA.

    The Problem

    In April 2018 I was laid off from my job. In September of 2018, we engaged a CFP to review our financial situation and make recommendations in in the areas of Cash Flow analysis, investment analysis, retirement capital needs analysis, education planning, the advisability of doing future Roth conversions, how to take my pension payout, and what to do with my 401K. When talking with her about seeing whether it would make sense to do Roth conversions now when our income is down, she said she was not a CPA but could do a high level Roth analysis was just to analyze possible tax stratagies, and that we should retain a CPA before making any moves that could impact our taxes. During our meetings, I don’t remember telling her that I had already done a Roth conversion already in 2018 and don’t remember her asking. On the account/asset list I gave her to do the planning, my IRA Rollover account only had $43 since I had rolled almost all of those funds into my 401K, but this evidently did not catch her attention.

    When we got her recommendations, besides the investment, cash flow, spending level, pension payout recommendations, and high level Roth conversion analysis (convert 35-40K per year from taxable account). She recommended rolling my 401K to into an IRA, which I did one week later. Not being familiar with the requirement of listing my total IRA balance on Form 8606 line 6, it didn’t occur to me that I needed consult a CPA. I had to call Fidelity to do this, and they did try to get me roll the funds back to my Fidelity IRA instead of Vanguard because they didn’t want to lose this significant amount of money. Unfortunately, They didn’t mention the tax implications of rolling my 401K money into any IRA since I had done the Roth conversion in 2018, namely, that I would now have to report very large IRA balance on Form 8606 Line 6, which would make all of my $59K rollover of my basis taxable.

    Best I understand, since Roth recharacterizations are prohibited under the new TCJA tax plan, I am stuck with this huge increase in my taxes for 2018. Am I missing something? Is there a way out?

    #3213

    Alan S.
    Participant

    No, there is no way around the conversion being mostly taxable. I have responded to you on other sites, but didn’t for a couple days to this post to let others respond, but no takers.

    #3233

    cjmassey
    Participant

    Alan:

    Thanks for taking the time to respond here and on the other forums. I hard lesson learned for me!

    #3235

    Alan S.
    Participant

    While it is costly in terms of higher current taxes on the conversion, in the long run you might recover all or most of these taxes. Your TIRA balance will be lower by the amount of this conversion plus future gains on the conversion. That will reduce your RMDs every year indefinitely, and could prevent your MAGI from rising high enough to make your Medicare premiums surcharged, etc; The extent of this benefit depends on what your average marginal rates are in retirement compared to the tax rate paid on the taxable portion of this conversion. Rates are also scheduled to rise in 2026, and your conversion came in a year of lower tax rates.

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