A Taxing Experience

I’m not a tax accountant, nor do I play one on TV, but I recently learned that something I took for granted for decades should have been tracked, for decades. I’m talking about the exciting topic of IRA basis. Overlooking its importance can cost you money and complicate your tax filings. Caution: this story may cause drowsiness, nausea, increased heart rate, and/or uncontrolled expletives.

The following background is basic and doesn’t go into exceptions, variations, and limitations. It’s presented primarily as a starting point for the journey to the cautionary tale upon which I promise to arrive.

Traditional IRAs began in the mid-1970s, under the Employee Retirement Income Security Act (ERISA). The purpose was to provide security for employees’ retirement funds, which had experienced losses due to company failures and underfunded pension plans. IRAs allowed employees to fund their own retirement with both pre-tax (tax-deferred) and after-tax dollars, with taxation on previously untaxed principal and earnings payable upon future withdrawals. In 1997, the Taxpayer Relief Act of 1997 added the Roth IRA, which allowed after-tax investments and future tax-free withdrawal of earnings.

Back in the early ‘80s, as companies saw opportunities to reduce or eliminate pensions, the federal government began to develop further laws and incentives that reduced companies’ retirement plan costs and encouraged workers to save for their own retirement. In 1978, under the Revenue Act of 1978, subsection (k) was added to Section 401 of the Internal Revenue Code, thus creating the popular 401(k) plans that developed. In November 1981, based on a model created by benefits consultant Ted Benna, the regulations clarified how businesses could use the regulations, and workers could make their own contributions. Some company plans in the early ‘80s were somewhat hybrid, as companies adjusted to the new normal.

Roth 401(k) plans came into existence in 2006. The difference was that traditional 401(k) plans were funded with pretax employee contributions (investments), while Roth plans were funded with after-tax dollars. Company matching contributions were likewise non-taxable for traditional, and taxable in the year made for Roth contributions.

When employees left the companies, they often had options to leave their vested funds in the accounts, move them to a new employer’s plan, or convert them to IRAs. The long-term nature of the various retirement plans, the plethora of options, and the ease of leaving 401(k) funds in company plans or converting them to IRAs often led to a “set it and forget it” investment outlook. Taxes weren’t something to worry about. But as the days approached when taxes would be due, a little worry (and planning) might have been appropriate.

In my case, I converted several employers’ 401(k) plans to traditional IRAs at a few points in my career, mostly for the purpose of consolidation. When I retired several years ago, I developed and adopted a strategy of converting enough of my traditional IRAs to Roth IRAs so that my eventual Required Minimum Distributions (RMDs) wouldn’t put me into a higher tax bracket or incur Medicare surcharges (which can be significant). What I didn’t think about was how much of my investments to that point had already been taxed. Fortunately, at the federal level, it was only a small amount. However, at the state level, where traditional IRAs were already taxed, the amount was significant.

I realized the problem shortly after filing my 2025 taxes, and went into a panic thinking that I’d either given up a tax advantage, or worse, set myself up to pay taxes again on money for which I’d already been taxed, which is known as the basis. As a result, I spent many hours searching through my old tax and investment records to determine whether taxes had already been paid or not. By locating Forms 1099R, 8606 and 5498, I was able to reconstruct my basis. By tracing my conversions from 401(k)s to IRAs, and various bank account changes over the years, I was able to confirm that I hadn’t missed anything.

The good news was that I was able to correct my federal filing with an amendment. The bad news was that my state filing was too complicated to correct with an amendment, so I decided to correct it going forward. It means that I’ll lose the tax benefit on some of the funds, and effectively pay taxes twice on some of the same income, but that seems to be the less painful path.

The lesson learned was that even though I thought I was doing the smart thing by leaving my retirement savings alone, I should have kept better records along the way, and tracked my basis, conversions, and accounts more diligently. Now that I’ve sorted things out, I think I’ve made it easier for my heirs to navigate, and that will make my ultimate retirement a whole lot less stressful.