A Roth IRA is nice in that withdrawals are tax-free*. In the simplest case, you just throw money into it, and when you take the money out, it’s tax-free.
The asterisk on “tax-free” says it’s not always tax-free. You get the simplest case if you wait until you are 59-1/2 for all your withdrawals (you also must have opened your first Roth IRA at least five years before then). It’s more complicated if you take money out before you are 59-1/2.
Some say a Roth IRA can be used as an emergency fund because you can withdraw the “principal” of your contributions at any time, tax-free, no questions asked. It’s true. However, if you ask me now how much “principal” I currently have available in my Roth IRA for this type of withdrawal, I have no idea. Do you know yours?
I haven’t tracked how much “principal” I contributed to my Roth IRA over all these years. Even though I kept all my tax returns, only conversions to Roth were on the tax returns. Direct contributions weren’t. My Roth IRA also moved a few times. My current Roth IRA custodian doesn’t know whether or how much I contributed to my Roth IRA in 2001.
This calls for the need to create and maintain a spreadsheet for your Roth IRA contributions and withdrawals. You record only the in’s and out’s — what happens inside the Roth IRA or between two different Roth IRAs doesn’t matter. The spreadsheet should have these columns:
- Tax Year
- Transaction Type:
- contribution
- conversion, the taxable portion
- conversion, the non-taxable portion
- distribution (withdrawal)
- Amount
- Available For Withdrawal
For this purpose, you treat all your Roth IRAs as one large Roth IRA (but your Roth IRA and your spouse’s Roth IRA are separate). If a conversion is partially taxable, you do two entries, one for the taxable portion, and another for the non-taxable portion. The “Available For Withdrawal” column is initially the same as the Amount column. You then update it as you take withdrawals. You have to do that because withdrawals from a Roth IRA must follow a specific order:
- First your contributions so far
- Then the taxable portion of the first conversion
- Then the non-taxable portion of the first conversion
- Then the taxable portion of the second conversion
- Then the non-taxable portion of the second conversion
- … …
- Earnings
If you are married, you have to have two separate sheets, one for each person.
Depending on the type of money and the timing, the tax treatment on the withdrawal is different. Sometimes it’s tax-free penalty-free. Sometimes you pay a 10% penalty but no tax. Sometimes you pay tax but no penalty. Sometimes you pay both tax and penalty. If you do multiple withdrawals before 59-1/2, it will be very difficult to tell what type of money you are withdrawing and what types are left in your Roth IRA unless you maintain a spreadsheet like this.
Here’s a math exercise:
You were 30 when you first contributed $2,000 to your Roth IRA. You contributed $2,500 in the second year, and you converted $5,000 to Roth, all of which was taxable. In the third year you didn’t contribute but you withdrew $3,000. In the fourth year you contributed $3,000 and then withdrew $6,000. What’s the tax treatment on this $6,000 withdrawal?
If you throw in some rollovers or recharacterization it will be even messier.
Too complicated? I think so. I cop-out by not planning to take any withdrawal from my Roth IRA before 59-1/2. To those who will retire early, I say if someone must touch their Roth IRA before 59-1/2, they don’t have enough saved.
However, even if you don’t plan on it, you never know what will come up in the future that makes it beneficial to withdraw from your Roth IRA before you are 59-1/2. You’d hate to find out you don’t have good records when you want to do it. So if you are still under 59-1/2, get that spreadsheet going now and retrace your history of Roth IRA contributions and distributions.
Here’s my spreadsheet template, filled in with sample data from the math exercise above.
The 5498 forms you received from your IRA custodian(s) will help you reconstruct the history. Did you save those? I didn’t save them in the early years. Now I have some homework to do too.
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ameridan says
It is much easier to use a finance program like Microsoft Money to keep track of everything regarding your IRA accounts (if not ALL of your accounts). And it’s free! It even prompts you for the tax year that contributions are to be applied to, and will generate a tax report ready for importing into your tax software.
The program is no longer supported by Microsoft, but unlike Quicken, there is no need to request assistance working out quirks and bugs. See my blog at https://microsoftmoneyoffline.wordpress.com/ to get you started.
Baughman says
Really interesting article. If the brokerage itself has no idea what you contributed, and if you yourself don’t, would the IRS know? If not, couldn’t you make crap up in your favor? How would your claims ever be disproven?
I envision a change in the future in reporting that helps clarify this. Just as cost basis is now handled by brokerages, I think the responsibility of tracking Roth IRA contributions will fall to brokerages over time.
Harry Sit says
You have the burden of proof on any number you put on your tax return. If you can’t prove your withdrawal before 59-1/2 is tax free and penalty free, it will be taxable and subject to penalty.
Evan says
What about a Roth 401(k) that has been rolled over into a Roth IRA? Is that considered a non-taxable conversion or a contribution?
Thanks
Harry Sit says
Not sure. I’d have to check the IRS publications and resources, which I don’t have access to right now.
gfmels says
The basis in the roth 401k is treated as regular contributions in the roth ira after it’s rolled over. Earnings from the roth 401k continue to be treated as earnings.
Harry Sit says
Thank you. That means when you rollover from Roth 401k you have to record how much you contributed to the Roth 401k up to that point. When you rollover from one Roth 401k to another Roth 401k, you should record the contributions versus earnings too; otherwise that information gets lost.
lynneny says
Or, you can just max out your Roth IRA contribution every year — the limit is pretty low and it’s a good financial move anyway — and you’ll know exactly how much you contributed.
I’ve had a Roth for a dozen years and it took me less than 5 minutes to figure out how much I’ve contributed. The Roth IRA wikipedia entry has a little chart right at the top with the contribution limits for every year since Roths started in 1998.
Harry Sit says
Only if you don’t hit income limit and you don’t make any conversions. Once you start withdrawing before 59-1/2, you still need to track how much in contributions you already withdrew and how much remains available.
D says
I don’t get this:
taxable conversion
non-taxable conversion
A conversion is a taxable event, there may be no gain because the taxpayer had basis in a non-deductible IRA or after tax dollars from a qualified plan, but the conversion is the event, and the amount converted is your basis.
Also, for conversions you may want to annotate when the 5 year on withdrawing penalty free from conversions lapses.
What am I missing? Is there something you are tracking with these labels?
Harry Sit says
A shorthand for “taxable part of a conversion” and “non-taxable part of a conversion.” The date column determines when the five-year mark is reached.
Andrew says
I think there’s an error in the spreadsheet. In years 1 and 2, you contribute $2k and $2.5k, but your “Amount Available for Withdrawal” remains $0 in both years. Shouldn’t it be $2k the first year and $4.5k the second year, since you haven’t made any distributions yet?
After all, you make those distributions later, and in the notes you point out that you’re distributing the contributions from years 1 and 2. If you’re distributing them, then must be available to distribute.
Also, you state in the article, “The ‘Available For Withdrawal’ column is initially the same as the Amount column.” But this is not reflected in the spreadsheet.
Harry Sit says
Andrew – The spreadsheet is reflecting the end state after the $6,000 withdrawal in year 4. The “Amount Available for Withdrawal” column is updated after each withdrawal. After the money is distributed, it’s no longer available for withdrawal. Therefore the number changes to zero.
Mary says
Pay attention to what Harry is saying! I am in the exact same boat. I want to liquidate my Roth IRA, but I don’t have records to show what the principal amount is. I converted my full traditional IRA to a Roth IRA in 1997. It was, I believe, in the neighborhood of $20,000 – $30,000, but I didn’t keep up with the records. I have generally contributed the full allowable amount annually since then, and have my Form 5498 statements for, say, the last 8 years, and the IRS will only give you the last 10 years worth. I cannot ask the broker, because I have moved this account around a little over the last 20 years, and cannot even remember who had it when I converted it (if they are even still around.) I am fairly confident that the account is ALL principal, because any profit years were outpaced by many more losing years, and I’m certain that my investments over time have netted to a significant loss. But as Harry says, Roth profit and loss is not a taxable event, and so not reflected in tax returns. I don’t know how I can possibly provide proof for the withdrawal on my tax return. I wish the IRS could somehow provide it. I haven’t yet gotten on the phone with then because hold times are so long, but suppose I’ll need to. On the plus side, I’m almost 55, so only have a few years left to ride it out if I need to.
John says
Harry, I am assuming the After tax 401K contribution (with in service withdrawal to Roth IRA) is counted as a regular Roth contribution in the year it was rolled over to Roth, right?
Harry Sit says
No, it’s counted as a conversion.
John says
Harry,
What is the tax treatment for the After tax 401K contribution (with in service withdrawal to Roth IRA)? So if my 5498 says $10,000 rollover when I can access the $10,000 tax free?
Also if one no longer has forms 5498 for past years; how does one recreate the history? I do have my tax returns and wondering where it is indicated on the tax returns
Harry Sit says
The pre-rollover gains are taxable in the year of the rollover. Your plan will send you a 1099-R with the taxable amount. That same taxable part is subject to 10% penalty if it’s withdrawn within 5 years of the rollover and before 59-1/2. See Mega Backdoor Roth and Access To Your Money Before 59-1/2.
If you don’t have the 5498, the 1099-R from the plan has the gross distribution and the taxable portion. Those two numbers are also on your 1040 if that’s the only thing you did that year; otherwise the numbers were added together with numbers from some other activities.
John says
Hi Harry,
In 2018, I had a 401k account with a provision to do after tax contribution. In 2018, I did an in-service distribution of the basis to Roth and gains to IRA. I got 2 forms (5498) from Fidelity for each account.
I did nothing to this account in 2019. I noticed that Fidelity issued me another 5498 for the Roth account for 2019 indicating the fair market value.
1) What is the purpose of the 2019 form?
2) I assume I can keep the 2018 form 5498 and use that to indicate my basis if I ever need to withdraw my contributions tax-free before 59.5, correct?
Harry Sit says
The custodian is required to issue a 5498 form every year whether you had any activity or not. Because electronic storage is practically free and unlimited these days, just keep all of them. Maintain the spreadsheet so you will know which form to dig up when needed.
Shankar says
My contribution for 2021 year, was initially assigned to 2022 and has now been reassigned back to 2021 by the brokerage. Is reporting of contribution year changes to a Roth IRA (due to error on the part of the brokerage despite clear instructions) an hassle at tax return time – any penalties to expect?
Aside, is doing a Backdoor Roth contribution similar to requesting for a contribution year change – in that, you make investment into a Traditional IRA and then follow up with the brokerage asking them to move the money to a Roth account?
Harry Sit says
Correcting a mistake in which year the Roth IRA contribution was for doesn’t cause hassle or penalties when you file your tax return. There are different ways to move money. A Backdoor Roth has to be done in a specific way. See Backdoor Roth: A Complete How-To.