Advanced Underwriting Consultants

Ask the Experts – August 2

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  My client is 54.  He did one Roth conversion is 2007, and another in 2011.  If he takes a distribution from his Roth IRA now, what is the order of distributions from the Roth IRA?

Answer:  Here’s an edited excerpt from Publication 590:

Ordering Rules for Distributions

If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions and rollover contributions from qualified retirement plans) and earnings are considered to be distributed from your Roth IRA….

Order the distributions as follows.

  1. 1.      Regular contributions.
  2. 2.      Conversion and rollover contributions, on a first-in, first-out basis (generally, total conversions and rollovers from the earliest year first). See Aggregation (grouping and adding) rules, later. Take these conversion and rollover contributions into account as follows:
    1. a.      Taxable portion (the amount required to be included in gross income because of the conversion or rollover) first, and then the
    2. b.      Nontaxable portion.
  3. 3.      Earnings on contributions.

In this example, assuming the taxpayer has made no regular Roth contributions to the Roth IRA, a withdrawal will come from the 2007 conversion first.

Why is that important?  Well a nonqualified distribution to a pre-59 ½ taxpayer from amounts converted within the last five years are generally subject to an extra 10% penalty tax.  In this case, if amounts are distributed from the 2011 conversion, they would be subject to the penalty tax.  So the ordering rules help make sure that the taxpayer dips into the oldest conversion—in this case, one that happened more than five years ago—first.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.  

Question of the Day – December 21

Ask the Experts!

Here’s the question of the day.

Question:  My 45 year old client purchased her only Roth IRA three years ago with a $100,000 Roth conversion.  The Roth IRA is now worth $90,000.  If she surrenders the Roth, is she entitled to an income tax deduction?

Answer:   Perhaps, but under these circumstances it may not provide any net benefit.

Treasury Regulations Sec. 1.408A-6 says that all Roth IRAs must be aggregated for the purpose of calculating the tax treatment of distributions.  The IRS holds generally that for a loss position to be recognized, the asset must be fully surrendered.  That means that for a Roth IRA tax loss to be potentially available, all the taxpayer’s Roth IRAs must be surrendered, with a net loss being the aggregate result.

In this example, the facts are that the converted Roth is the taxpayer’s only Roth.

When the taxpayer surrenders the Roth IRA, there is a $10,000 loss.  The IRS’s position that the loss is deductible, but only if the taxpayer itemizes on the tax return.  Further, the loss is considered a miscellaneous expense, so it is only deductible to the extent the taxpayer’s total miscellaneous expenses exceed 2% of AGI.

Finally, the taxpayer must consider the tax implications of surrendering amounts associated with a conversion within five years of the conversion.  The rules say that a taxpayer younger than 59 ½ who withdraws converted amounts from a Roth IRA within five years of the conversion must pay the 10% penalty tax on the amounts withdrawn.  In this example, it would mean a $9,000 penalty tax on the $90,000 distribution.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.