Should you keep your IRA’s separate? Or combine them?
A new client sent me a question the other day. They have several IRA’s from various 401k rollovers and IRA contributions.
Some of those 401k’s had AFTER-TAX contributions in them. Having multiple IRA’s, and trying to figure out the logistics of moving their IRA’s to my firm for management, they wondered how the IRA’s should be handled?
Should they be kept separate? Merged or combined together somehow?
This isn’t a grey area, IRA’s are viewed as one by the IRS
The IRS makes it VERY clear that IRA’s – whether they have after-tax contributions or pre-tax contributions – are all treated the same. They’re treated as if they were one account, regardless of how many you have.
This means that any “basis” you have in your IRA (meaning your total after-tax contributions), have to be considered as part of the larger IRA balance. It doesn’t matter which account you pull the IRA distribution from. That basis is withdrawn under the pro-rate tax rules.
It’s like a cup of coffee. Once you put a little bit of cream in it (the IRA basis, or the amount of after-tax contributions), you can’t separate the cream from the coffee. Every time you pour some coffee out of the cup, a little bit of the cream comes with it no matter what.
IRA basis example
Say for example a client has 5 IRA’s totaling $500,000. In those IRA’s there’s $50,000 of after-tax contributions (basis).
No matter what IRA distributions come from, that basis (which is 10% of the total) must be taken into consideration.
Basis is returned in the distribution tax free, pro-rata, since it was created with after-tax contributions.
Be wary non-deductible IRA rules and Roth conversions
WATCH OUT! Some sneaky investors who aren’t eligible to fund a ROTH IRA (or a regular IRA) fund a NON-deductible IRA account. Then they convert that non-deductible IRA to a ROTH IRA thinking they can do so on an account by account basis.
This doesn’t work! Well, actually it MAY work under recent rulings if there are NO OTHER IRA accounts, but anyone who’s not eligible for a ROTH or IRA contribution very likely has other IRA’s somewhere.
The strategy above doesn’t work because that non-deductible IRA is now treated as part of the TOTAL IRA account balance. This means that the conversion of that non-deductible IRA account to a ROTH is going to be partially (very likely MOSTLY) taxable if there are other IRA’s.
Also keep in mind that if you combine your IRA’s you should avoid 60 day rollovers at all costs! You cannot have more than once in a 12 month period, and having multiple 60 day rollovers going can invalidate any or all of them.
Instead, combine your IRA’s at the same custodian using trustee to trustee transfer paperwork.