What does Line 22 Basis in Roth IRA contributions mean in Form 8606?

Question

What does Line 22 Basis in Roth IRA contributions mean in Form 8606?

If I an correct, in traditional IRA, the basis, as in 8606, is the portion of the balance due to nondeductible contribution.

Is the basis in Roth IRA a similar concept?

Thanks.

Answer 1

TLDR: It's similar but with significant differences.

In both cases, the basis consists of previously-taxed inputs not previously withdrawn.

Per your previous question on trad IRA, distributions from a trad IRA are taxed (as ordinary income) except a prorated portion of the basis. The normal case is that people make deductible contributions, have zero basis, and thus everything is taxable -- contributions from past years plus investment gains over the years. In the case you do have basis from nondeductible contributions, effectively you get credit for it spread evenly throughout your retirement.

For a Roth IRA, contributions are never deductible, thus always post-tax; conversions from trad to Roth are also taxed when made and thus post-tax once in the Roth. When you withdraw, everything is normally tax-free both contributions/conversions and gains, except if you take distributions which are not 'qualified' and exceed your contributions/conversions in which case the excess is taxable.

A qualified distribution requires that you be age 59.5 up or disabled (or dead and the distribution to your beneficiary or estate) or some cases that the legislators decided it's okay for you to break the implied deal that you get the tax break only if you save for retirement: unusually high medical expenses, higher education, buying a first home, reservist called to active duty. A qualified distribution must also be after the first 5 years you have the Roth IRA.

Unlike a trad IRA, if and when you take unqualified distributions, your contributions/conversions are considered to be withdrawn first (and nontaxable), and the gains last. Thus your basis at any time in a Roth IRA is the total contributions/conversions i.e. post-tax money put in, less any portion you've already 'used up' in previous years. Because this requires carrying forward computations over potentially many years on Form 8606 it is rather complicated, using a worksheet in the instructions online now for 2016 but will change in future; both current and past-year instructions (and forms and yearly publications) in PDF can be downloaded from the Forms and Publications page.

If you start withdrawing earlier than normal retirement but only gradually, this treatment maximizes the chance you reach the 5-year and 59.5-or-exception thresholds before the tax on gains kicks in.