Convert IRA to Roth IRA

[Guest tjpera]

I've read about the issues involved in rolling my traditional IRA (TIRA) into my Roth IRA (RIRA), but I'm still unclear about the taxes, if any, that I'll owe upon conversion. I've already paid taxes on $8000 in my TIRA. Also, in June 1999 I rolled over my 401k balance of $57,200, on which I had paid no taxes, into my TIRA. At this time, my TIRA looks like this:

TIRA Portfolio Value Report as of 8-25-01

Security Cost Basis Gain/Loss Balance

Cisco Systems 21,589.81 -12,464.81 9,125.00

EMC 19,669.50 -16,229.50 3,440.00

Kopin Corporation 18,017.25 -11,142.25 6,875.00

MCData Corp. 0.00 125.13 125.13

Nortel Networks 9,683.88 -8,800.13 883.75

Oracle 5,549.62 3,564.38 9,114.00

Sun Microsystems 47,587.81 -27,677.71 19,910.10

-Cash- 376.44 0.00 376.44

TOTAL Investments 122,474.31 -72,624.89 49,849.42

Thus I have a lot of capital losses in the TIRA. We're under the $100,000 AGI conversion threshold, so if I roll my TIRA into my RIRA, what will my tax liability be?

Thanks very much for the help.

[John G]

Too bad you co-mingled 401k with IRA money. If you had not, you could have rolled the IRA into a Roth and only pay taxes on the amount over the 8k. Now, the assets are blended and like scrambled egg, you can't separate the yolk and whites any more.

I was confused by the math you presented, so I will leave the potential tax bill to Barry and the other accountants at this site. Because your circumstances are complex, you definitely should rely on a local accountant to assist you before you take any further action.

I have a much BIGGER issue that should be addressed. You were not really investing with these assets but rolling the dice on a very narrow niche. You have five stocks involving internet/networking switching, storage or hardware: Cisco, Sun, Nortel, MCData and EMC. Oracle provides server/internet software. Kopin focuses on semi conductors and flat screen displays. By any reasonable measure, that is way too many eggs in one tech basket.

You probably are painfully aware of the actual (can't use potential here) limitations of this investment approach.

I bring this up because there are lots of novice investors that read this message board who may be able to benefit from your example.

Beware the narrowly based portfolio!

Seven stocks representing seven different industries is just the begining of a diversified portfolio. This portfolio was seven stocks in the essentially the same industry, no bonds, no cash.

Retirement investing for most folks should not be making big wagers on a few stocks in one industry. Investors do not need to look for a "grand slam" in every at bat. You can win the big game if you can string together lots of singles and doubles. The average investor will achieve great results if they can get a 10 to 12% annual gain over the long haul (think decades). Sectors with 50% and 100% gains should be viewed with great suspicion. A small play is fine, just don't bet the farm.

Inclined to treat Roth/IRAs (the great tax shelter) as a pool of assets for long shot bets? Don't. I don't think anyone is clever enough to pull it off, the stock market just has too many unknown driving forces. If you must gamble, restrict it to Powerball.

[Guest tjpera]

Hi John, thanks for the reply. I'll be talking with someone about this today. I'll report back. What I'll be asking him is, on the $8000 on which I've already paid tax, is it true that I won't owe tax when I roll over the traditional IRA (TIRA) into the Roth IRA (RIRA)? Also, of the remaining $57000 that was transferred as cash into the TIRA, there are capital losses on the stocks I bought. So is it true that I won't owe tax on this portion when I roll over the TIRA into the RIRA?

Thanks also for your thoughts about diversified portfolios. I agree with you 100% that putting all eggs in one basket is a recipe for disaster, and you perform a service by pointing this out. In my own case, I've never regarded my decisions to invest in any company as gambling. I take risks and seek rewards, and I'm as comfortable now about owning these companies as I was when I bought them. So for similarly minded investors (people who are willing to put up with high volatility on a long road to potentially high returns within a diversified portfolio), or people who want to get started investing, I wouldn't want to raise alarms unduly about these companies/industries. High-tech will endure despite big fluctuations, and I believe these companies as a group will show that long term.

Thanks.

Tim

[John G]

Tim, You can not selectively convert just part of an IRA to obtain benefitial treatment. All IRA assets are blended together. This is even true if the assets are with different custodians. For example, you might have 4 different IRA accounts two at one custodian, and the other two with separate custodians. From the IRS perspective, all conversion mathematics are done as if all the assets were in one big pile at one custodian, and you can not convert just a favorable part. All conversions are done using percentages for the overall pie to figure taxable amounts.

I am not an expert on the accounting issues of the 401k side, but I don't believe that your capital losses will have any impact on a conversion since the 401k has already been rolled into an IRA. You need to have an tax/accounting expert look at your very specific facts and layout your options.

I agree with your comments about the long term prospects of tech stocks. You portfolio included some very good companies and did not include the very speculative dot.com's. The problem is that you just have too large a percent of your investments in a narrow area. You can also find some great techs in medical devices, pharmacuticals, etc. and it would not hurt to pick up something in media, retail, leasure/entertainment to give your portfolio better balance.

[Guest JKG]

If

(1) the value at the time of conversion is $49,849.42,

(2) you have made $8,000 of nondeductible contributions,

(3) you convert the entire account, and

(4) this is your only IRA,

then you must include $41,849.42 ($49,849.42 less $8,000) in income.

[Guest Dan Simonds]

Custodians don't seem to allow the combination, in one account, of a Roth IRA that accepts ongoing contributions and a Roth IRA that was funded by a Conversion. Why should this be a problem and does the IRS prohibit this or is it just a custodian issue? It's easier to have all Roth money in just one account and maybe saves some fees as well.

[John G]

When Roths were first created a few years ago, there were some technical distinctions that caused distinctions between conversion and contributory accounts. Changes in the regs has caused this annoying problem to go away. Most custodians know this. Either: (1) your talking with someone who is not current on the rules, or (2) your custodian just never bothered to correct their internal rules. Ask to speak to the backroom IRA department. If they don't agree that you need just one account you can always find another custodian.