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Emptying a Roth IRA account

  1. I saw an example near the end of this webpage trying to illustrate how to calculate loss in traditional IRA for deduction.

    At the beginning of the tax year, Bill has an IRA with a balance of $24,000 (my understanding: deductible + nondeductible contributions). His basis in it is $15,000 (my understanding: nondeductible contribution).

    But during the year his IRA investment balance dropped by almost 50% to $13,000.

    So the value of his IRA dropped $11,000 (= $24,000 - $13,000)

    The $11,000 loss ate up $9,000 (= $24,000 - $15,000 basis) of his tax-deferred earnings (my understanding: deductible contribution), as well as $2,000 into his basis of $15,000. So he could claim a $2,000 loss, after he withdraw all is IRA money.

    If I understand correctly, his deductible loss is calculated as his basis minus end-of-year balance, i.e. $15000 - 13000 = 2000.

    But his end-of-year balance $13000 consists of the part from the deductible contribution, and the part from the nondeductible contribution.

    The part from the deductible contribution should be taxed as ordinary income.

    His deductible loss should be the loss for the nondeductible contribution, and has nothing to do with the deductible contribution and its part in the end-of-year balance, i.e. the deductible loss is $11000 * 15000/24000, assuming the proportion between deductible and nondeductible parts in the end-of-year balance is still same as in the original contribution.

    Is my understanding wrong?

  2. In another similar example (example 2 on another webpage), it says

    (He) would owe no taxes or penalties on this distribution (my understanding: withdrawal), because it's effectively a return of his original investment.

    I don't quite understand why there is no tax or penalty. I remember for traditional IRA, withdrawal of deductible contribution and its earnings is subject to ordinary income tax, and if withdraw earlier than a certain age, there will also be penalty, while for Roth IRA, withdrawal of nondeductible contribution can be any time and without penalty.

Thanks and regards!

marked as duplicate by JoeTaxpayer, mhoran_psprep, littleadv, Dilip Sarwate, Dheer Jun 11 '12 at 9:45

This question has been asked before and already has an answer. If those answers do not fully address your question, please ask a new question.

  • You may disagree, but I ask different questions. – Tim Jun 10 '12 at 17:28
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    others might offer their observation. In my opinion, if you have a specific question, let's ask and answer. Asking questions about Q&A from other sites isn't helpful, but again, in my opinion. You're asking questions about the same issue, but from slightly different perspectives. Yet, never spitting out the numbers needed to just solve your issue and move on. The topic itself is fine, but not so complex that it needs 3 or 4 separate questions to address. – JoeTaxpayer Jun 10 '12 at 17:54
  • I only have one Roth IRA, but I asked about traditional IRA here, just because I want to understand. – Tim Jun 10 '12 at 17:57
  • I have voted to close this question because no matter how clearly the matter is explained, OP Tim refuses to understand what has been said and refuses to accept the meaning that everyone else (including the IRS, and even more important, the courts) attaches to various words. Perhaps this is because it does not fit his world view of what the rules are, and so he asks the same questions in slightly different words, hoping that someone will give an answer that agrees with him. – Dilip Sarwate Jun 10 '12 at 21:58
  • @DilipSarwate: I didn't refuse to understand .... What I am doing is trying to figure out why I don't understand. – Tim Jun 10 '12 at 22:09
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First, to clear up your misconceptions:

  • The balance is not merely made up of deductible and non-deductible contributions. There are also earnings implied in the balance .. i.e. the whole reason you invest in the first place is to realize some return on investment. That return, a.k.a. the earnings, are included in the balance of the account. The balance is the sum total of everything in the account, the "bottom line".

  • Generally speaking, basis for an account is all of the money that has been contributed (deposited) to the account. In the context of an IRA as described in the article, however, they are using basis to refer to only the non-deductible contributions. Of note, however, is that basis specifically excludes earnings. If you have deposited, say, $5000 one year and $5000 the next, then your basis is $10,000, even if the balance has grown to, say, $12,000 (which includes the earnings).

  • As may be evident by now, earnings are not equivalent to deductible contributions. Earnings may arise from such contributions but they are not the same. Rather, earnings are the net positive investment results from all contributions. Again, if you had contributed $5000 one year and $5000 the next and the balance has grown to $12,000, then the earnings portion is $2000.

So to interpret what happened in the specific example provided:

  • Over the years, the account holder contributed (deposited) a total of $15,000 into his account. These must have been non-deductible contributions in the case of the IRA in order to arrive at basis of $15,000.

  • Over time (and coincident with the deposits), that $15,000 grew to $24,000 .. i.e. earned $9,000 in earnings.

  • Then, the nearly 50% drop caused the balance to decay to $13,000. This means all $9,000 of his earnings were wiped out, plus $2000 of the original basis.

  • The remaining $13,000 is all basis .. that is, considered to be original money deposited to the account, no earnings.

  • In effect, the account has lost $2000 of basis, because $15,000 was deposited and only $13,000 remains. Simplistic way of looking at it: A $15,000 investment resulted in a final $13,000 sale, i.e. a net loss of $2000. It doesn't matter that it hit $24,000 in the meanwhile .. it could have hit $250,000 in value and then dropped to $13,000 and the net result would be the same: a loss of $2000 in basis.

  • Traditional IRA earnings are always tax-deferred .. i.e. whether earnings arise from deductible or else non-deductible contributions, when one takes a distribution (withdraws) from an IRA and the distribution includes earnings, the earnings portion is always taxable income. Doesn't matter if the earnings arose from one kind of contribution or the other.

  • I don't think in this example there were any deductible contributions whatsoever.

Does that make sense / help?

  • It is not necessarily the case that there are no tax-deductible contributions in this case; there could have been lots of them, but they don't matter as far as taxes are concerned. All that matters is that the total distribution $13,000 (following which all IRA accounts of a particular type have value $0) is less than the total basis $15,000 and so there is a $2,000 loss that might be deductible on Schedule A. The tax-deferred contributions, if any, and the earnings from them, if any, do not matter. Loss if total distribution < basis, taxable income if total distribution > basis. – Dilip Sarwate Jun 10 '12 at 23:54
  • Chris: Thanks for your reply and understanding! I think the example allows deductible contribution to the traditional IRA. Also you can click the second example, which is basically the same as the first one, and it explicitly mentions there are two kinds of contributions: deductible and nondeductible. So the basis is equal to the nondeductible contribution. – Tim Jun 11 '12 at 0:36
  • @Dilip: The final total distribution may include part of deductible contribution and its earning, why is the deductible loss computed as total distribution minus the basis (i.e. the nondeductible contribution), instead of "the part of the total distribution that is generated from the nondeductible contribution" minus the basis? – Tim Jun 11 '12 at 0:40
  • @Tim Ask your Congress-critter why. They make the laws. Since you don't like the law, campaign to elect a Congress-critter who will vote to make the law read the way you want it to. – Dilip Sarwate Jun 11 '12 at 1:20

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