I am 79 years old, long retired and subject to required minimum distributions. There is often an excess of distributions from my IRA over that required for living expenses. That excess is transferred to a brokerage account and duly reported and taxes paid. Now, I have recently been advised that I can open a Roth and transfers to this will count as MRD. This strategy will, of course, permit the tax free accumulation of yields in the Roth. I suspect that I have missed something and there is really no Santa Clause, especially hiding out in the IRS. If this question provides a cause for professional hilarity I will understand. Thanks
There was a recent article by Scott Burns that implied this. He is an excellent financial writer, and I can only give him the benefit of the doubt and assume an editor made a gross error.
That said, RMDs must come out first. The amount disbursed can NOT be put into a Roth. It's taxed to the extent it contained pre tax funds. After the RMD, you are permitted to convert existing IRA money to a Roth account, paying the tax upon conversion. I suggest you understand your marginal rate and consider a strategy wherein you 'top off' your current bracket each year. (i.e. convert enough to create taxable income to just put you to the top of your present bracket.) I have an 84 yr old woman who has room enough to convert $10K/yr while staying at 15% rate. Her Roth balance is growing and her RMDs are level despite the higher percent she has to take each year.
Here is the Scott Burns Q & A and the correction that was later posted. Q. I have a question regarding my IRA and 401(k) accounts. This year I reached 70 ½. I am told that I have to start taking money out of these accounts. What type of account should I put this money into once it has been distributed? I am currently living on Social Security and a state pension. The IRA and 401(k) funds are to be used for a nursing home, if needed. ?E.M.W., Austin, TX
A. If you don?t need the money for supporting your standard of living, one option is to treat the RMD as a Roth conversion. Open a Roth IRA, and reinvest the after-tax proceeds. In the Roth account all future growth and distributions will be tax-free.
Another option is to start building a cash reserve account. It won?t earn much in interest and what it does earn will be taxable, but it will provide you with readily accessible cash if you need the money for vacations or health emergencies. The advantage of having a cash reserve account is that you can spend that money without creating a ?taxable event.? Any money taken from your IRA or 401(k) accounts is taxable income.
Finally, if you turned 70 ½ this year (2010) you will need to make the Required Minimum Distribution before the end of the year. The amount will be determined by the value of the account at the end of 2009 and the formula used for calculating your RMD. Do this before year end.
Important correction and clarification for this column:
It is incorrectly stated in the column above that retirees over 70 ½ can convert required minimum distributions (RMDs) from IRA and 401(k) accounts into Roth IRAs. To clarify, only after the RMD has been completed and taxes paid, can you start a conversion of the remaining balance.
The column also suggests that a person should take their Required Minimum Distribution before the end of the year in which they turned 70 ½. The rules actually allow a person to take their first RMD by April 1 of the year following the year in which they turn 70 ½.
This would not be tax-wise, however, because the second distribution would have to be taken by the end of the same year. In effect, the person would be taking two taxable distributions in the same tax year. Here is how this rule is stated in the IRS regulations:
"An account owner must take the first RMD for the year in which he or she turns 70 ½. However, the first RMD payment can be delayed until April 1st of the year following the year in which he or she turns 70 ½. For all subsequent years, including the year in which the first RMD was paid by April 1st, the account owner must take the RMD by December 31st of the year."
Are you saying that the RMD must "come out first" _in time_???
My RMD payments come from IRA accounts that are all invested with TIAA-CREF. TIAA-CREF has an optional MDO (Minimum Distribution Option) plan, under which they calculate what your required RMD for a given year will be early in January of that year; send you a letter saying what that number is; then pay it to you in equal quarterly installments on March 31, June 30, Sept 30, and Dec 15th. Once you set this up, you can just let it run, year after year, as we've done and continued to do
Last year (i.e., during 2010) my wife and I also instructed them to convert an additional single lump sum -- actually larger in size than our total RMD for the year -- from our IRA accounts into a Roth, on a date in August (i.e., at a time when the Sept and Dec RMD payments had not yet been dispersed).
So, our total RMD did not "come out first", relative to the Roth conversion action. Are we in trouble?
No, that's fine. Your RMD was calculated based on the previous year-end balance, and is being fully withdrawn without respect to any conversion.
What the rule says, is that if you want to convert your *entire* Trad. IRA, first you subtract the RMD, then whatever amount is left is eligible to be converted.
What would not work, in your situation, is to convert the *entire* remaining balance in the middle of the year, before your final two RMD installments are withdrawn. But you didn't do that.
Mark - I gave Schwab paperwork for a small conversion (for an 84yr old, just to top off her 15% bracket in 2010), they called her and said they would not put it through until after her RMD was withdrawn. Nothing else unusual, both the conversion and RMD amounts were
Q?6. Can an individual who has attained at least age 701/2by the end of a calendar year convert an amount distributed from a traditional IRA during that year to a Roth IRA before receiving his or her required minimum distribution with respect to the traditional IRA for the year of the conversion?
A?6. (a) No. In order to be eligible for a conversion, an amount first must be eligible to be rolled over. Section 408(d)(3) prohibits the rollover of a required minimum distribution. If a minimum distribution is required for a year with respect to an IRA, the first dollars distributed during that year are treated as consisting of the required minimum distribution until an amount equal to the required minimum distribution for that year has been distributed.
(b) As provided in A?1(c) of this section, any amount converted is treated as a distribution from a traditional IRA and a rollover contribution to a Roth IRA and not as a trustee-to-trustee transfer for purposes of section 408 and section 408A. Thus, in a year for which a minimum distribution is required (including the calendar year in which the individual attains age 701/2), an individual may not convert the assets of an IRA (or any portion of those assets) to a Roth IRA to the extent that the required minimum distribution for the traditional IRA for the year has not been distributed.
(c) If a required minimum distribution is contributed to a Roth IRA, it is treated as having been distributed, subject to the normal rules under section 408(d)(1) and (2), and then contributed as a regular contribution to a Roth IRA. The amount of the required minimum distribution is not a conversion contribution.
On Jan 4, 5:06 pm, Alan quoted a correction issued by Scott Burns as follows:
The first three paragraphs (but not the last) appeared in Scott Burns's column in our local newspaper this morning with minor modifications in some wording (e.g. "My column of Thursday Dec. 23...." instead of "...in the column above...") BUT with the MAJOR difference that the three occurrences of 70 in the first two paragraphs have been replaced by 70.5 (actually, 70 followed by the case fraction for 1/2). Thus,
In fact, the article posted at
has 70.5 in all of the above places AS WELL AS in the last paragraph which is claimed to be a quote of IRS regulations:
So, what *is* the rule? If it is as stated by Scott Burns, then it would mean that a person turning 70 in the latter half of 2010 (and thus 70.5 in 2011) could delay taking the first RMD until 04/01/2012, but must take the second RMD by 12/31/2011? and the third RMD by 12/31/2012? That doesn't seem to make sense....
Alan, thanx for your excellent research as usual (and Joe, thanx for your real-world observation).
In the end, doesn't this just amount to a conversion two-step? (something similar to what you used to have to go through to get a 401k into a Roth IRA -- first rollover to Trad. IRA, then convert)?
In other words, the money you thought your were converting, but really weren't (due to the chronological ordering rules within the same calendar year), is now a Roth contribution, which you can recharacterize to a non-deductible Trad. IRA contribution, and then convert to Roth from there?
It all seems to boil down to giving the instructions in the right sequence to your broker, and There Is More Than One Way To Do It, even if the result is the same. If only the IRS had to follow the same "step transaction" rules that it imposes on taxpayers....
Well the way it's supposed to work is that your trustee is supposed to inform you that you have to take your required distribution before you can convert. Charles Schwab did what they were supposed to do. They would not allow a conversion before the MRD was taken as the Regulation says. I've seen about 4 different trustees handle this and they all knew the rule about the MRD coming out first. If the amount of any MRD winds up as part of the conversion, the rule states that the amount is considered to have been distributed (taxable income) and then contributed to the Roth IRA as an annual contribution. If the taxpayer is not allowed to make annual contributions (no compensation or already maxed out), then the taxpayer has an excess contribution to a Roth IRA and is subject to the excess contribution excise tax unless the funds are removed. If the Roth contribution is allowable, the funds can remain in the Roth IRA. However, they are not considered to be part of the conversion. No spreading the taxes over two future years. A contribution can be removed at any time tax free and without penalty. Not true of amounts converted. Conversions have their own 5 year period. The five year period for contributions started on Jan. 1 of the tax year that the Roth was created. See the ordering rules for Roth distributions.
And my point was, can't either of these two things (regular Roth contribution or excess accumulation) be recharacterized before year-end as a Trad. IRA contribution, and then immediately converted to Roth?
Not if one can't make new deposits in the first place. The law as Alan cited seems to add this rigid timing to avoid any risk that enough funds won't be there to support the proper RMD. (Of course, the law could have been written to ignore it, and the solution is to reverse enough of the conversion to suffice.
Back to my real life retiree - since she struggles just balancing her check book, I tried to spare her the quarterly tax payments. Her RMD is enough to cover her entire tax bill and then some, so, given the fact that the tax withholding from an RMD can be done once near year end, I have her full year tax bill paid from that. The result (as I'm now clear) is that we're not permitted any conversions earlier in the year. I was considering the strategy of converting $10K cash + $10K of one particular ETF, and before next April, recharacterizing the lesser performer. That would now come at the cost of the year's interest on the RMD or my dogging her on quarterly payments. I'll pass. Joe
Yes, I see now -- if you're old enough to have a RMD, then you're old enough to not be allowed a Trad. IRA contribution, so never mind.
Also, above where I wrote "excess accumulation" I should have used "excess contribution", the correct term.
Exactly. Other than enforcing tax withholding, I wonder since when is it the government's job to protect us in advance from the consequences of not following the tax law? Anyone can legally choose not to take a RMD if they pay the excise tax that results (it would be silly to so, of course, but it's still the taxpayer's choice).
Wouldn't the tax-free gain from the remaining Roth conversion more than offset 11 months or so of lost interest on her tax payment (withholding on the RMD)?
Also, if it helps, you have until Oct (the unextended due date) to recharacterize the conversion.
It is not said explicitly, but (c) could be read to say that it is okay to contribute the after-tax RMD to a Roth IRA. That isn't right is it? Wouldn't any new contribution to a Roth IRA first require that there be compensation income at least equal to the contribution amount in that tax year? So if he has no W-2 wages or business income, he cannot make a new Roth IRA contribution. He can convert the existing regular IRA, whatever is left after the RMD, but that's not the action suggested in (c) above.
Compensation income includes W2 income or self-employment income. But could compensation income also include distributions made from partnerships? If yes, could he invest in something like an oil and gas MLP and treat the
20% of distributions that is not return of capital as business income, then contribute into a Roth IRA up to that amount?
Compensation income normally excludes investment income, but it is not clear to me whether this would apply to income distributions from public partnerships.
No, it is not right, and it's not what it says. It says that if you did so it would be treated as a contribution, not a conversion. Thus, if there wasn't taxable compensation during the year to support a contribution, it would be an excess contribution subject to the 6% penalty.
The "Thus if there wasn't taxable compensation" qualification is in your text, not in the text of (c) above.
The qualification would be implied to a tax professional, but would not necessarily be clear to a layman, and the original question was posted by a layman.
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