IRA Rollover

Archive for September, 2010

Question: IRA basis question?

I don’t really understand how basis can affect the taxibility of the money I withdraw from a traditional IRA and Roth IRA.

Suppose I withdrew $45,000 from a traditional IRA and the basis for that is $65,000.. what effect would it have? Since I withdrew less than the basis, so is my withdrawal taxfree? (assuming there are no rollovers/conversions) What differences would I have if it was a Roth IRA instead? Thanks so much.

Answer: First, are you sure your basis in your traditional IRA is $65,000? Generally, unless you made after-tax contributions (that is, contributions that you did not deduct on your tax return), you do not have basis in your traditional IRA.

If you do have basis in your IRA, the tax-free amount of your distribution is figured as follows:

Distribution X IRA basis/total value of IRA at the beginning of the year = tax-free amount of distribution.

For example, say your IRA was valued at $200,000 1/1/08 with basis of $65,000 and you withdraw $45,000. Applying this formula, $45,000 X $65,000/$200,000 = $14,625. So, $14,625 of the distribution would be tax-free and the remaining $30,375 would be taxable.

When you take your distribution, you must complete Form 8606 to calculate the taxable and tax-free portions of the distribution.

Also, keep in mind that regardless of taxability, an early distribution penalty may apply if you withdraw IRA funds before age 59 1/2.

The Roth IRA works differently. You can withdraw your basis (that is, the contribution portion of the IRA) at any time and for any reason tax and penalty free. However, the earnings portion of the Roth is withdrawn tax and penalty free only if you’ve had the Roth at least 5 years and another qualifying event applies. For most people, that event is turning 59 1/2.

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