If you have an IRA, there’s an IRS form that you should be aware of. It’s called Form 5498—IRA Contribution Information. In short, Form 5498 outlines any transaction in which money transferred into an IRA for a given year. It’s issued by your broker or financial institution overseeing your IRA.
This isn’t a form that’s required for your tax return—in fact, many Form 5498s are issued after the tax filing deadline in a given year. This article aims to give a light overview of this form, and a very important tax planning opportunity that you can discover using this form.
What is Form 5498?
As mentioned, Form 5498 is issued by the financial institution responsible for your IRA. It is issued for any year in which money or securities were transferred into that account. This could include (but is not limited to):
An account holder will receive a Form 5498 for each account. So, if you make a non-deductible contribution to your traditional IRA, then do a backdoor Roth conversion, you would receive a Form 5498 for both your traditional IRA as well as your Roth IRA. In addition, you would receive a Form 1099-R since money went from your traditional IRA.
What does this mean?
For most people, it probably doesn’t mean much. This simply is an acknowledgement of the money you contributed to your IRA in a given year. For people who are eligible to directly contribute to a Roth IRA, or to fully deduct traditional IRA contributions on their tax return, this form won’t mean much.
However, there is a situation where this will come in handy: When your traditional IRA ends up having a combination of deductible (pre-tax) & non-deductible (after-tax) contributions. While there are probably many scenarios where this occurs, I’ll outline two common ones:
At the beginning of your career, you start off in a lower tax bracket. You contribute directly to a traditional IRA while contributing to your workplace retirement plan in order to maximize your retirement savings. Over time (unbeknownst to you), you creep into the income phase out limits for being able to deduct your IRA contributions on your tax return. Your IRA now has a combination of pre-tax and after-tax contributions.
You’ve been making non-deductible IRA contributions for a while, but might not have converted them to a Roth IRA. You change jobs-as part of this change, you change your 401k participation. To simplify your finances, you rollover your previous 401k. You now have a combination of pre-tax contributions & after-tax contributions.
How do I figure out which contributions were pre-tax and which ones were after-tax?
This is a good question. Over time, it can be very confusing to keep track of this. Fortunately, you can use your Form 5498, in conjunction with each year’s tax returns to figure this out.
To do this, you compare Block 1 (IRA contributions other than amounts in boxes 2-4, 8-10, 13a, and 14a) to the ‘IRA deduction’ line on your tax return. Based upon year, you’ll find this line item as follows:
2019: Schedule 1, Line 19
2018: Schedule 1, Line 32
2017 & prior returns: 1040, Line 32
One of three things will happen:
The number in Block 1 equals the respective number on your tax return. This means that your IRA contribution was fully deducted for that year, and is considered a pre-tax contribution.
There is no number for IRA deduction on your tax return, but there is a number in Block 1 of your 5498. This means that your IRA contribution was not deducted at all that year, and is considered an after-tax contribution.
There are numbers in both forms, but they’re different. This means that your IRA contribution was partially deducted in that year. The difference between the two numbers is the amount of your after-tax contributions.
This usually happens when you’re in the phase-out of your IRA contribution deduction eligibility. For example, in 2020, a single tax filer can fully deduct their IRA contribution if their modified adjusted gross income (AGI) is $65,000 or less, but cannot deduct anything if their modified AGI is $75,000 or more. The area between $65,000 and $75,000 is the phase-out, which means the contribution is partially deductible.
You’ll need to calculate this amount for each year that you contributed to an IRA. The total number is the total of your after-tax contributions.
What is the tax planning opportunity?
Well, if you are doing Roth conversions (or would like to do so), you might be able to do so without paying taxes on your after-tax IRA contributions. In fact, if you keep track of how much your pre-tax contributions actually were, your tax professional will be able to incorporate this into your tax returns as you do those Roth conversions, which will lower your tax bill.
There are even situations in which you may be able to convert only the after-tax contributions, while keeping your pre-tax contributions in a pre-tax account. Converting only the after-tax contributions would allow you to avoid paying taxes on any pre-tax contributions. How to do this while staying compliant with the Tax Code depends on a variety of circumstances and is beyond the scope of this article.
What’s important is that you know how much of your IRA is from pre-tax contributions. This will allow you to create your Roth conversion strategy.
Does my accountant need Form 5498?
Most likely, not. Form 5498 is an informational form and not required to file a tax return.
However, as you do Roth conversions, you may need your Form 5498s (or at least the running total as outlined above), as well as your old tax returns, so your tax preparer can properly calculate your tax liability. Your tax preparer might not need to see them personally, but they do need to have some assurance that the numbers you are giving are based upon fact, and not just pulled out of thin air.
More importantly is that you have this documentation in the case you are audited. Talking with an auditor when you have all the facts in hand is a much different story than when you ‘think’ you know the numbers. Having your Form 5498s and tax returns allows you to avoid tap-dancing in front of the examiner.
What you must do before starting your conversions
The most important thing that you do is to discuss the strategy with your accountant before you start doing conversions. You want to achieve 3 things:
Your accountant knows of your strategy and agrees with it. By preparing your tax return, they’re going to be telling the story after the fact. So it’s worth making sure they’re onboard with the big picture before moving forward. And if not, then it’s worth taking the time to learn what adjustments you need to make so they’re onboard.
You’ve reviewed that year’s plan as part of your tax planning. This is a little different.
*A Roth conversion strategy is big picture, which might encompass several years of conversions.
*The Roth conversion plan pertains to what you’re doing that year, after making necessary adjustments.
* For example, your 5-year strategy might allow you to convert $50,000 per year. But in Year 3, your tax planning appointment shows a one-time capital gain because you needed to sell some investments to generate cash. You might lower that year’s conversion to $40,000 to account for that.
You’re comfortable with the actual mechanics. This means that if you need to open a Roth IRA, then you actually open the Roth IRA. Likely, your accountant will be in a situation to advise on what you should be doing, but might not be in control of the actual transactions. That falls to you or your investment advisor (if you have one). If you’re working with an investment advisor, then your accountant and investment advisor should be on the same page in terms of what needs to be done and when.
What if I can’t find my Form 5498s?
Contact your financial institution. You should be able to have them send you copies for each year that you deposited funds into an IRA they manage. This is the preferred approach.
If you have changed custodians over the years, or are converting many years of IRA contributions, this might be difficult. However, if you keep paper (or electronic copies) of your statements, you should be able to document when deposited funds reached your IRA. This might not be the preferred approach, but it could allow you to explain the history of deposits to your examiner.
In either case, you should discuss what documentation you do have with your accountant, so they can decide how to proceed.
More important are the tax returns for each year. They contain the information telling you how much of your contributions were deducted (pre-tax), and how much were never deducted (after-tax).
Developing a Roth conversion strategy can be challenging. However, if you’ve ever made after-tax contributions to your IRA over the years, it’s important to account for them as you implement your Roth conversion strategy. Not doing this literally leaves tax savings on the table—money that should be working to support you in your retirement years.
If you’ve read this article, and still feel stuck on what to do, you should talk with your accountant or investment advisor. If you don’t have one, or they can’t give you a good answer, then contact us. We’d be happy to schedule a complimentary phone call to see how we might be of service to you.