Ask The Experts: Money Matters

By Mike Miles

Voluntary contribution options

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Q. I’ve been getting mixed advice regarding my voluntary contributions options. I was planning to ask OPM to send the (post tax) VC contributions to a new Roth IRA so I can more easily track the five-year holding requirement, and send what minimal interest accrued during the brief time the account will have been open to my TSP (if OPM will transfer such a small amount) or simply let them withhold 20 percent and send me the accrued interest.

However, I also have a small basis in an old traditional IRA because of a recharacterization several years ago, and now I’ve been told this leftover basis may have a negative impact on my disposition of VC funds. I had hoped to transfer the pre-tax amount in the traditional IRA to my TSP before mandatory withdrawals kick in, and to get rid of the remaining basis in the traditional IRA by converting it to a Roth (since post-tax money would not be accepted by TSP) .

But I’m now concerned that the rules regarding IRA conversion will trigger additional tax liabilities on the monies transferred from VC to Roth as well. I’ve been told — I hope erroneously — that the IRS requires that we combine all conversions from all types of accounts, and therefore taxes might be assessed on the VCs as well (because it would be averaged with the existing basis in the unrelated IRA and need to be withdrawn proportionately. It’s hard to believe that’s the case, but I certainly don’t want to find out the hard way that the large sum of post-tax contributions in the VC would then be subject to income tax because of the conversion to Roth. Say it isn’t so! If that were the case, an additional annuity funded with VC contributions + interest becomes a more viable option than Roth conversion – but it’s been hard to get a straight answer. Can you advise?

Does having a basis in a traditional IRA have a negative impact on my planned conversion of post-tax VC contributions to a Roth? If so, does conversion to Roth of the IRA basis alleviate the problem for the voluntary contributions conversion to Roth?

A. You may not selectively withdraw or otherwise remove after-tax money from an IRA account. If the account contains basis, then each dollar is considered to be partly basis and party taxable when removed. You must also follow the rules for aggregating certain types of accounts when removing money. So, for example, if you have two accounts, each with $50,000, and one of the accounts contains $10,000 in tax basis, then each dollar of each account is considered to consist of 10 percent basis and 90 percent ordinary taxable income. Basically, this means that when you covert you’re the after-tax portion of your VC account balance to a Roth, you’ll have to consider a portion of that conversion taxable. These rules are complex and you should consult a CPA – the one who will prepare your tax return and defend it – before proceeding any further.

 

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