What Is Unrecovered Roth Contribution Basis?

Roth IRAs offer tax-free withdrawals in retirement, but tracking contributions is essential to avoid unnecessary taxes and penalties. The “unrecovered Roth contribution basis” refers to the portion of after-tax contributions that has not yet been withdrawn, which affects how distributions are taxed.

The IRS does not track individual contributions, so account holders must maintain their own records to ensure proper tax treatment and avoid overpaying taxes or misreporting income.

Calculating Contribution Basis

The after-tax money in a Roth IRA comes from contributions, rollovers, and conversions. Since these amounts have already been taxed, they can generally be withdrawn tax-free. Understanding how each type of deposit affects the overall basis helps ensure accurate reporting.

Contributions

For 2024, individuals can contribute up to $7,000 to a Roth IRA, or $8,000 if they are 50 or older. These contributions, made with after-tax dollars, do not provide an immediate tax deduction and form the foundation of the contribution basis.

For example, if someone contributes $6,000 annually for five years, their total contribution basis would be $30,000. This amount remains separate from investment earnings, which may be taxable if withdrawn early. Because the IRS does not track contributions, taxpayers should keep records of yearly deposits. Form 5498, issued annually by financial institutions, helps confirm contribution amounts.

Rollovers

A rollover moves funds from one retirement account to another without triggering taxes if done correctly. When rolling over funds from another Roth IRA, the contribution basis remains unchanged. However, employer-sponsored Roth accounts, such as a Roth 401(k), require special handling.

If a Roth 401(k) is rolled into a Roth IRA, only the after-tax contributions count toward the basis, while earnings from the 401(k) are subject to Roth IRA distribution rules. For example, if an individual rolls over $50,000 from a Roth 401(k), with $35,000 in contributions and $15,000 in earnings, only the $35,000 is added to the basis. The $15,000 remains separate and may be taxable if withdrawn before meeting the five-year rule or age 59½ requirement.

Conversions

Converting funds from a traditional IRA or pre-tax retirement account to a Roth IRA requires paying taxes on the converted amount in the year of conversion. The portion of the conversion that was previously taxed, such as non-deductible contributions to a traditional IRA, becomes part of the Roth IRA contribution basis.

For example, if someone converts $20,000 from a traditional IRA to a Roth IRA and $5,000 of that amount represents non-deductible contributions, only the $5,000 increases the basis. The remaining $15,000, which was tax-deferred, does not count toward the basis and will be treated as earnings within the Roth IRA. Tracking conversions using Form 8606 is essential to avoid double taxation.

Adjusting Basis for Various Transactions

The contribution basis in a Roth IRA changes over time due to withdrawals, recharacterizations, and excess contribution corrections.

Withdrawals of contributions reduce the basis dollar for dollar with no tax liability. If a distribution includes converted amounts or earnings, additional rules apply. For example, if someone with a $40,000 basis withdraws $10,000, their basis decreases to $30,000.

Recharacterizations allow individuals to reverse a prior contribution by moving it to a different type of IRA. If a Roth IRA contribution is recharacterized as a traditional IRA contribution, the original amount is removed from the Roth IRA basis. For example, if a $6,500 Roth contribution is recharacterized, the Roth basis decreases by that amount.

Excess contributions occur when an individual contributes more than the allowable limit. If the excess is removed before the tax filing deadline, it does not impact the basis. However, if it remains in the account, it may be subject to a 6% excise tax each year it remains uncorrected. Removing an excess contribution after the deadline may require withdrawing earnings as well, potentially leading to additional tax and penalties.

Distribution Ordering Rules

Roth IRA withdrawals follow a specific sequence to determine which funds are accessed first, affecting tax liability and penalties.

The first withdrawals always come from direct contributions, which can be taken out at any time without taxes or penalties.

Once contributions are withdrawn, converted amounts are accessed next. Each conversion must satisfy a five-year holding period to avoid penalties, even if the account owner is over 59½. If a withdrawal occurs before this period ends, a 10% penalty may apply unless an exception, such as disability or a first-time home purchase, is met. Conversions are withdrawn in a first-in, first-out (FIFO) order, meaning the oldest conversions are accessed first.

After contributions and conversions are depleted, any remaining withdrawals come from earnings. If earnings are withdrawn before age 59½ and before the Roth IRA has been open for at least five years, they are subject to income tax and a 10% penalty. If both conditions are met, earnings can be withdrawn tax-free.

Implications of Incorrect Basis Reporting

Failing to track the contribution basis accurately can lead to unnecessary taxes, penalties, and complications when filing returns. Since the IRS does not maintain a record of individual contributions, any errors in reporting fall on the account holder. If the basis is understated, withdrawals that should be tax-free may be misclassified as taxable income. Overstating the basis could result in underreported taxable distributions, potentially triggering IRS scrutiny and penalties.

Errors in basis reporting can also create issues when calculating the taxable portion of nonqualified distributions. If an individual withdraws funds before meeting the five-year holding requirement, the IRS determines taxability based on the reported basis. Incorrectly low basis figures can lead to overpayment of taxes, while inflated amounts may result in underpayment and subsequent penalties.

Recordkeeping Approaches

Maintaining accurate records of Roth IRA contributions, conversions, and rollovers is essential for ensuring proper tax treatment of withdrawals. Since financial institutions do not track an individual’s contribution basis, account holders must document all relevant transactions.

Form 5498, issued annually by financial institutions, provides official documentation of contributions and rollovers. Keeping copies of tax returns, particularly Form 8606, is important for tracking conversions and non-deductible contributions. Individuals who make multiple conversions should maintain a detailed log of each transaction, including the amount, date, and tax paid, to ensure compliance with the five-year rule.

Bank statements, brokerage account summaries, and employer plan rollover confirmations also serve as useful supporting documents. Digital storage solutions, such as cloud-based recordkeeping or financial software, can help organize these records and ensure they remain accessible over time. Without proper documentation, taxpayers may struggle to prove their basis, potentially leading to higher tax liabilities on withdrawals that should be tax-free.