It’s fairly common that people with basis (after-tax money) in their IRA’s don’t know they are sitting on unrealized opportunity. Often enough, this opportunity is unintentionally squandered or turned into a financial mess. It’s the kind of mess for which I have to invoke the imagery of a tangled slinky.
First, lets presume you read “The 8606 Conundrum” and those problems don’t exist for you (at least, they don’t exist for you anymore).
Now that you know what your basis is, there are several strategies for IRA’s that contain after-tax dollars, and we have vast experience in all of them.
The first thing you need to know is that if you roll over your 401k into you IRA, or any IRA registered to you for that matter, you have just diluted the basis. I will, at some point, show you the math on dilution of basis so you can understand it better. Suffice to say it’s substantially difficult to separate your basis and get it growing tax free if you flood ANY of your IRA’s with a huge pile of tax deferred money.
The reason I say ANY IRA is that the IRS looks at all of your IRA’s to determine the ratio of basis to non-basis when you decide to later convert Traditional IRA assets to a Roth. You have to convert based upon the ratio, you don’t get to specify that you’re only converting basis.
The second thing you need to know is that you do not want the growth of your basis happening in your IRA if you can help it. That’s because you are growing tax revenues with after tax money. Stated another way, the growth of the basis is taxable as income when it’s withdrawn from the IRA.
We need to get your basis moved so that it’s growing tax free, not tax deferred. This can be accomplished a couple of ways; Through conversion (provided you have not diluted the basis), or basis isolation.
Where there are tax deferred assets in an IRA, a conversion is always (to some degree) a taxable event. Converting large amounts of money when basis makes up very little of the conversion on a ratio basis can detonate a bunch of different tax landmines. Careful analysis will reveal whether the time to convert is now or it’s better to wait. We have a proprietary tool to show your optimum schedule for conversion (I know it’s proprietary because I designed it).
After the window is identified, we cooperatively use CPA’s to avoid detonating one of the tax traps and set the strategy in motion.
The next procedure is called Basis Isolation, but it isn’t available to all. If your current company sponsored plan will accept IRA assets, you can pull this off. The best part, you’re getting the basis into the Roth without a taxable event. This requires phone calls and paperwork, which we do with you present. The essence is that you send the basis (as reported on your 8606 and add current year contributions) to the Roth, then the remaining balance to the custodian. If you do an isolation, ALL of your IRA balances will need to be ZERO until the beginning of the next year at which you can start funding the IRA again or do a Rollover. DO NOT fund the account after you isolate.
If this sounds confusing it’s because we’re dabbling in the dark arts of financial planning. Taking something like this from concept to execution requires the right relationships- no robot, website, or financial journalist will help you reconstruct your basis and set an appropriate strategy for conversion or isolation. You need a professional, and we’re here to help, so don’t hesitate to call us.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss you specific tax issues with a qualified tax advisor.