The last possible cost basis recovery option is

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The last possible cost basis recovery option is reserved for those who annuitized (turned their retirement plan into an annuity with a series of payments). These clients will also use a pro-rata cost basis recovery calculation, but this one is different from the above discussion. Consider a client who has a 403(b) and decides to annuitize their balance when they retire next month (on their 65 th birthday). By annuitizing, this client will no longer have an account where they can take ad hoc distributions if a need arises. However, they will have a guaranteed (by the financial health of the insurance issuing company) series of payments during retirement. Assume that this annuity is a life annuity (payments for life) with a 25-year period certain (payments for at least 25 years minimum) and that the client has a cost basis in their 403(b) of $40,000. The cost basis recovery is $133.33 ($40,000 / 300 [25 x 12]) per monthly payment. If this client’s monthly annuity payment were $1,133.33, then they would enjoy $133.33 tax-free and the other $1,000 would be received as fully taxable income. Once the client recovers all of their cost basis (perhaps cost basis is specifically designed to be recovered faster than the annuity term), then all distributions become fully taxable. This could happen if the client lives longer than the 25-year window that the cost basis recovery was designed to accommodate. Q: An IRA-owner has non-deductible contributions of $25,000 in his traditional IRA which is valued at $300,000. He plans to take a distribution of $20,000 and understands that the non-deductible contributions have created a tax-free cost basis. He thinks that the full $20,000 will be tax-free. Is he correct? A: No, he is not correct. The non-deductible contributions will be subject to pro-rata cost basis recovery because they have been co-mingled with deductible-contributions and the inherent growth of those two types of contributions.
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Q: Reconsider the IRA-owner who has non-deductible contributions of $25,000 in his traditional IRA which is valued at $300,000. He still plans to take a distribution of $20,000. What is his cost basis recovery? A: His cost basis recovery will be $1,666.67 ($20,000 x [$25,000/$300,000]). This means that he will have $1,666.67 of tax-free income, 18,333.33 of taxable income, and $23,333.33 of remaining cost basis yet to be recovered in the future. Roth IRA Distributions There may be either a qualifying or a non-qualifying distribution from a Roth IRA. This distinction applies only to the growth portion of the Roth IRA balance. Contributions into a Roth IRA can be withdrawn tax- free and penalty-free at any time. Consider Becky, who has contributed $3,000 per year for 10 years into her Roth IRA. The Roth IRA now has a balance of $62,500. Becky can withdraw up to the $30,000 that she has contributed without taxes or penalties. If she exceeds that dollar amount, then the following discussion will apply.
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