So, say your Roth IRA balance is $100,000. If you’ve contributed exactly $90,000 to your account since opening it, this would be your Roth IRA basis. Knowing your Roth IRA basis comes in handy in a number of situations, especially, to figure out how much money you’ve put into the account and how much money your contributions have earned.
How Does a Roth IRA Basis Work?
One major benefit of a Roth IRA is that you can withdraw your basis (aka, your contributions) at any time without penalty or taxes — as long as your account is at least five years old or you meet certain other criteria. The reason such withdrawals get complicated is, as your account grows and starts earning interest, it can be difficult to know exactly how much you’ve contributed versus how much interest you’ve earned. This is where the Roth IRA basis comes in. For example, say you’ve saved $6,000 in your Roth IRA for the past five years, for a total basis of $30,000. Based on Roth IRA rules, you could withdraw this amount at any time without incurring a penalty from the IRS.
How To Calculate Your Roth IRA Basis
Calculating your Roth IRA basis is fairly simple and can be done in two steps: The math may not be tough but getting the accurate information may prove challenging.It may require some digging if you’ve had your account open for a long time. Doing these calculations for the first time may take a bit of time. But once you’ve done it, you should be able to update it fairly quickly throughout the year. As an example, say you’ve had your Roth IRA open for 10 years. Your contributions and distributions are as follows:
Year 1: $500 contributionYear 2: $2,500 contributionYear 3: $1,000 contributionYear 4: $3,000 contributionYear 5: $3,000 contributionYear 6: $4,000 contributionYear 7: $1,000 contribution; $3,000 distributionYear 8: $2,000 contributionYear 9: $6,000 contributionYear 10: $6,000 contribution
Your total contributions would be $29,000 and your total distributions would be $3,000. So, your Roth IRA basis would be $26,000.
How To Calculate Roth IRA Basis of Conversions
Before we talk about how to calculate your basis in a Roth conversion, let’s talk about how traditional and Roth IRAs are taxed in general.
Money in a traditional IRA isn’t taxed until retirement. So, any time you make a contribution, it sits in your account tax-free until you withdraw. Money in a Roth IRA is taxed upfront. So, you’ve already paid taxes on the money you put in your account.
This means that any time you make a Roth IRA conversion — which is where you transfer money from a 401(k) or traditional IRA to a Roth IRA — you have to pay taxes on the full amount. Now, think back to the definition of a Roth IRA Basis: it’s the sum of money in your account that’s already been taxed. Because of this, your Roth IRA basis of conversion is equal to the full amount you convert. So, if you do a Roth IRA conversion for $20,000, your Roth IRA basis is $20,000, plus whatever contributions you already had in the account.
What Roth IRA Basis Means for Individual Investors
There are a few reasons why you should know your Roth IRA basis:
Your Roth IRA Basis Helps You Track Penalty-Free Withdrawals
The biggest benefit of tracking your Roth IRA basis is that it takes the guesswork out of knowing if a withdrawal is qualified (read: penalty-free) or not. The last thing you want to do is take $10,000 out of your Roth IRA, just to find out you exceeded your basis and now have to pay taxes and penalties.
You Need To Know Your Roth IRA Basis For Tax Purposes
You’re required to fill out IRS Form 8606 in the years you make a Roth IRA distribution or Roth conversion. Line 22 of this form asks for your Roth IRA basis. The IRS also recommends keeping Form 5498 for your records, in case you get audited or need to verify nontaxable parts of your IRA distributions.
Your Roth IRA Basis Can Help With Retirement Planning
Understanding your Roth IRA basis can help you plan out a solid income strategy for retirement. So, if you’re trying to figure out which types of retirement accounts you need to pull from and when to stay in a lower income tax bracket, your Roth IRA basis can help with that.
