How to Calculate the Basis for Roth IRA Conversions

Basis is the after-tax money you convert to a Roth IRA from another retirement account.

Basis is the after-tax money you convert to a Roth IRA from another retirement account.

When you withdraw money from an IRA or a Roth IRA, the basis can be withdrawn tax-free, but it helps to understand what the basis is and how to calculate it. The IRA basis is money that has already been taxed. It can be from nondeductible IRA contributions, or from after-tax funds rolled over from another plan. IRA stands for Individual Retirement Account.

Roth vs Traditional IRA

Roth IRAs are different from traditional IRAs and 401Ks in that the money you contribute is taxed at the time it’s deposited. The money you put into a traditional IRA is pre-tax. That means you are not taxed on those earnings at the time you deposit the money into the IRA or 401K. That tax break is known as an income tax deferral.

The advantage to a Roth IRA is that the investment money you earn on your IRA will not be subject to income taxes. You do have to satisfy two other requirements, however. You must be 59½-years-old when you start withdrawing money, and you must have been participating in the plan for at least five years.

Transferring to a Roth

If you decide to transfer money from a traditional retirement account into a Roth IRA, you will most likely need to pay taxes on the money you’re converting into the Roth IRA. If you are converting money into a Roth IRA, that money, along with any contributions you make, becomes part of the basis.

Calculating the basis

For example, if you have a Roth IRA with $12,000, and you contributed $10,000 to it, your tax basis is $10,000. That $2,000 investment income is not subject to taxes.

If you withdraw after age 59½ and have had the account longer than five years, your tax basis is $12,000.

If you have made early qualified withdrawals, your contributions and conversions which are non-taxable are withdrawn first and the gains on your IRA are withdrawn last. Your tax basis will be your total contributions and conversions, minus what you’ve withdrawn.

If you fully convert a traditional IRA into a Roth IRA, you might think your tax basis is zero dollars because none of your contributions have yet been taxed. But you may have put in more money to your traditional IRA than the Internal Revenue Service allows you to deduct from your income. That’s $5,500 if you’re under age 50 or $6,500 if you’re over age 50. Those nondeductible contributions become your basis.

If you only partially convert a traditional IRA to a Roth, your basis is what you had in the traditional IRA. Say you had $100,000 in your traditional IRA, and $12,000 of that money is nondeductible funds. Your portion of that is 12 percent. If you decide to convert $50,000 of that account to the Roth IRA, your basis will be 12 percent of $50,000 or $6,000.

Filing taxes

When you file your taxes, your IRA basis is tracked on IRS form 8606. This form keeps a cumulative record of your basis, but it is up to you to ensure it is kept up to date.

Inherited IRA

IRA basis carries over to inherited IRAs. Withdrawals from Roth IRAs do not need to begin at age 70½, unlike traditional retirement accounts. This makes the Roth IRA appealing to leave to your heirs.

 

About the Author

Karen Gardner is a freelance writer and editor based in Maryland. She has more than 20 years of experience writing and editing health, home and gardening stories.

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