January 15, 2015 in Investing

Dear Liz,



I’ll be 70 1/2 next year and must start taking an IRA minimum distribution from my retirement accounts. I have several different IRAs but no Roth. One IRA I refer to as my “after-tax” IRA, since my contributions weren’t deductible. I’m thinking of taking my entire required minimum distribution out of the earnings in this account. Once I’ve drained all the earnings from the account, I’d like to roll the after-tax basis into a Roth IRA and let it start growing again. Is this a strategy that makes sense, or if I do this, will I have to enter into some complex proportional withdrawals factoring the Roth into the traditional IRAs’ RMDs?



— Chuck

Dear Chuck,



You typically don’t get to choose how your distributions are taxed. Every withdrawal you take from your IRAs usually is partly taxable and partly tax-free. The same is true of any conversion you would make from an IRA to a Roth.

The proportion of your withdrawal that’s tax-free will reflect how much of your total IRA savings consists of those nondeductible contributions.

Let’s say the total value of all your IRAs was $1 million on Dec. 31. Over the years, you’ve made $100,000 in nondeductible contributions, a proportion that’s 10 percent of the accounts’ current value.

Now let’s say you withdraw $38,000 from any account as your required minimum distribution. Ten percent of that, or $3,800, will be tax-free. The rest, $34,200, will be taxable income.

If you decided to convert any or all of your IRA money to a Roth, the same math would apply. Ten percent of the withdrawal wouldn’t be taxed, but 90 percent would.

Now, there might be a way to segregate the taxable and nontaxable amounts of your IRA if you were a participant in a 401(k), 403(b) or 457(b) plan, says Mark Luscombe, principal analyst with tax research firm Wolters Kluwer, CCH.

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The strategy would be to roll the taxable portions of traditional IRAs into the workplace retirement plan, assuming the plan would accept such a rollover. That would leave just the nontaxable portion in the traditional IRA, which you could then convert into a Roth. The IRS in 2014 issued some updated guidance on this strategy in Notice 2014-54, Luscombe says.

While that notice deals with distributions from workplace plans, the guidance it provides is helpful in isolating taxable amounts from after-tax amounts in separate IRAs, says Luscombe. However, this strategy might only work if you were still employed, with access to a retirement plan that allowed such a maneuver.

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