Roth conversion through a sweep account

Suppose investor has "mutual fund accounts" and "brokerage accounts" at a particular firm.

Traditional IRA is in a mutual fund. There is also a Roth IRA cash sweep account that is considered a mutual fund, and a Roth IRA brokerage account (invested in specific securities, not mutual funds).

To convert Traditional to Roth in this case, the firm would require first that the Trad IRA fund be sold and proceeds deposited into the Roth cash sweep account. This step would be the actual conversion. But really, the investor wants the money converted into the existing brokerage Roth IRA, so the cash is used immediately (next day) to purchase into the Roth IRA brokerage account.

Can this be treated for tax purposes as a conversion directly into the Roth IRA brokerage account? It could be an issue for recharacterization purposes. Suppose the Roth IRA brokerage account has lost money by mid-2012, and a recharacterization is desired to get back the taxes paid at conversion on what is now a loss. Would the process just be reversed? (Roth brokerage sale -> Roth cash sweep -> Trad. mutual fund)?

Reply to
Mark Bole
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This should not be the case. Conversions from Traditional IRA to Roth IRA should be made "in kind" not first liquidated. If you 'want' to sell and move as cash, of course that's your choice, but if your broker's default is not in kind, you should first be sure it's available on request. The conversion paperwork from Schwab simply asks what assets to move from one account to another.

Reply to
JoeTaxpayer

You need a new IRA custodian. They are wrong. There is no need to liquidate the account to convert it to a Roth account.

Reply to
D. Stussy

As I read the OP's remarks, it is the accountholder who wishes to change investments (as well as do a Roth conversion). Otherwise, the "Traditional IRA in a mutual fund" could just be Roth-converted as a standalone transaction.

What is described sounds to me typical of a Mutual Fund company that at some point branched out into being a brokerage (e.g. American Century) rather than a brokerage who also sells mutual funds (e.g. Schwab).

The "sweep account" and "brokerage account" are -- I am guessing -- part of the same single Roth IRA account from a tax perspective. Money moves between them as investments are bought and sold without those actions being considered transactions to/from a Roth account. (The OP can correct me if I'm mistaken here.)

The issue here seems to be how fast can the accountholder both make the investments he/she wants, and also do the Roth conversion.

Another facet here is that if the accountholder does what they are describing, they are commingling IRA funds that may be differently sourced. It is worth double-checking if this is advisable.

Steve

Reply to
Steve Pope

Mark wrote "the firm would require first that the Trad IRA fund be sold" which implied that wasn't his wish.

Reply to
JoeTaxpayer

Yes, but Mark also wrote: "the investor wants the money converted into the existing brokerage Roth IRA".

S.

Reply to
Steve Pope

keep going - "so the cash is used immediately (next day) to purchase into the Roth IRA brokerage account."

The investor wants an in-kind conversion, but whether true or not, believes the brokers will sell before transferring.

Reply to
JoeTaxpayer

I think that Steve has hit the nail on the head with the mechanics of the situation (brokerage account with fund company). But I am unclear of the OP's tax concern - it's hard to see any possibility other than what Steve described, which does away with any tax question.

[quoted text rearranged for discussion purposes]

On 7/27/2011 11:02 PM, Steve Pope wrote: > What is described sounds to me typical of a Mutual Fund company that at > some point branched out into being a brokerage (e.g. American Century) > rather than a brokerage who also sells mutual funds (e.g. Schwab).

American Century can hold all funds in a brokerage account, but Vanguard is notorious for forcing investors to hold Vanguard funds (excluding their ETF-class shares) in separate mutual fund accounts, outside of Vanguard Brokerage Services. There is no way around this.

Agreed - it sounds like a mechanics issue, not a tax issue - that the account holder wants to minimize the lag between selling and buying by eliminating the conversion operation from the sequence of events between the sell and the buy. The in-kind conversion is just a means to an end.

The problem is no different from own > The "sweep account" and "brokerage account" are -- I am guessing -- > part of the same single Roth IRA account from a tax perspective.

Which makes this detail (that there is a sweep account) or that the sweep is a MMF as opposed to a brokerage cash account irrelevant details from a tax perspective (it's all just one IRA).

Further, it seems legally necessary that the sweep account be part of the IRA, else each sweep out (e.g. when a security were sold) would have to be reported as a distribution, and each sweep in would have to be reported as a contribution. It is I believe for this reason, that WellsTrade will allow taxable accounts to use a third party account (e.g. a BofA checking account) as the transaction ("sweep") account, but will not allow third party sweep accounts for IRAs - Wells would be unable to track any withdrawals from the third party account, which would constitute IRA distributions.

Reply to
Mark Freeland

First thanx to Steve and everyone else for comments, sorry for the delay in getting back with clarification of my question.

The firm in my question is T. Rowe Price. Yes, there does seem to be a kind of wall between the mutual fund holdings and brokerage holdings. They are shown separately on the web site, and when you want to initiate online transactions and you start in one or the other category (mutual fund or brokerage), your subsequent choices all become limited to only other investments in that category.

No, it is strictly a tax issue, see my previously missing explanation below.

Ah, this is the heart of the matter. Yes, for certain purposes, separate IRA accounts at multiple firms are all considered one "virtual" account. This applies when considering basis of Trad. IRA and RMD's, for example -- all your Trad. IRA's are added together for a single total amount used in the calculations.

But my issue has very specifically to do with recharacterization of Roth conversions. In this case, separate Roth IRA accounts can be considered separately.

See TD 9056 and Notice 2000-39, "Earnings Calculation for Returned or Recharacterized IRA Contributions".

The gist of this is that when recharacterizing the earnings on a Roth conversion, "the net income attributable to a contribution is determined by allocating to the contribution a pro-rata portion of the net income on the assets in the IRA (whether positive or negative) during the period the IRA held the contribution."

Further, "in the case of an individual who owns multiple IRAs, the net income calculation is performed only on the IRA containing the contribution being returned, and that IRA is the IRA that must distribute the contribution."

This is my concern: investor needs the converted amount to go directly into the investment that might end up being used for recharacterization. If he cannot convert directly from mutual fund X in the Trad. IRA into stock Y in the Roth IRA, then I am asking if it is still possible to have a future recharacterization of Y back into X, assuming there was a one-day period where funds where held in cash.

He could certainly convert from mutual fund X in the Trad. IRA to mutual fund X in the Roth IRA (in-kind), but that's not what he wants to convert into, and it doesn't seem like the tax law creates any such restriction.

So, maybe it will just require even more phone time with T. Rowe Price to find someone who understands the issue.

Reply to
Mark Bole

It seems to me that to do what you are saying you want to do, the investor would need to set up a new separate borkerage account (with associated sweep account) for the purposes of investing this conversion in stock Y. Otherwise, a future recharcterization would reflect all the investment activity in the existing brokerage account and not just the stock Y purchase.

And I don't see why this should be any problem to do it this way, unless as I mentioned earlier the investor cannot do all the transactions he/she wants to do quickly enough. Which right now in the markets is potentially significant. For example, this investor could view the available choices for money-market mutual funds for the sweep account as too exposed under current market conditions. Certainly this is a big question right now. I have myself reduced exposure to this type of investment in the past two weeks.

Steve

Reply to
Steve Pope

The net income calculation is performed on the account that holds the investments that the t/p wants to recharacterize. You describe this as a Roth IRA that is a brokerage account. It doesn't matter that the original conversion moved through another Roth IRA (Roth Cash Sweep) before winding up in the Roth that holds the stock. Steve Pope's reply is correct in that if the t/p does this, then all of the investments in that Roth brokerage account are used for the net income calculation. I can't tell from your two posts, whether the t/p cares if that happens. If the t/p does not want that to happen, then Steve's recommendation to isolate the conversion to a new Roth IRA is also right on. Once the net income calculation is performed, the distribution must be moved back into a traditional IRA. That can be any traditional IRA.

I sense you may be concerned about the fact that the original conversion went into the sweep account and that the recharacterization is coming out of the brokerage account. I don't see this as a problem as there is no requirement that the recharacterization come from the Roth that originally received the transfer. I've looked at two different recharacterization forms and both of them ask which account or accounts you want to use for the recharacterization if you don't want to use the account where the conversion was made. One of those forms was from T Rowe Price. The other was from Vanguard.

Reply to
Alan

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