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 – April 11

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 73 year old client participated in a designated Roth account as part of her former employer’s 401K plan.  She left a substantial balance in the account when she retired earlier this year.  Is she required to take required minimum distributions (RMDs)?

Answer:  Yes.

The RMD rules that apply to regular 401K account balances also apply to designated Roth accounts.  If the client was not an owner of the company sponsoring the plan and retired from the plan-sponsoring employer this year, she must take an RMD from the account based on the December 31, 2012 designated Roth account balance.

The first RMD must be taken on or before April 1, 2014.

The client can avoid having to take post-2013 RMDs during her lifetime by rolling over the designated Roth account to a Roth IRA.  Roth IRAs have no RMD requirements while the taxpayer is still alive.

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 – March 13

Ask the Experts!

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

Question:  My client intends to make an after-tax $5,000 IRA contribution in April of this year.  The client intends to convert the after-tax IRA to a Roth.  Later in the year, the client will roll over an existing $95,000 pre-tax IRA account balance to the client’s 403(b) plan.  Will the Roth conversion be a non-taxable event?

Answer:  Surprisingly, the answer is yes.

When a taxpayer takes a distribution from a traditional IRA, or converts a traditional IRA to a Roth, the distribution or conversion is treated as coming pro-rata from the pre-tax and after-tax parts of the IRA.  Furthermore, the IRS says that all IRAs must be aggregated for the purpose of figuring out how much of the distribution is taxable.

In the example given, one would expect that the conversion of the after-tax traditional IRA occurs while another pre-tax IRA exists, the conversion will be mostly taxable.  Fortunately, that’s not how it works.

Here’s what Revenue Code Section 408(d) says:

    (d) Tax treatment of distributions

      (1) In general

Except as otherwise provided in this subsection, any amount paid or distributed out of an individual retirement plan shall be included in gross income by the payee or distributee, as the case may be, in the manner provided under section 72.

      (2) Special rules for applying section 72

        For purposes of applying section 72 to any amount described in paragraph (1) –

          (A) all individual retirement plans shall be treated as 1 contract,

          (B) all distributions during any taxable year shall be treated as 1 distribution, and

(C) the value of the contract, income on the contract, and investment in the contract shall be computed as of the close of the calendar year in which the taxable year begins.  (Emphasis added.)

          For purposes of subparagraph (C), the value of the contract shall

          be increased by the amount of any distributions during the

          calendar year.

The Code Section says you need to do the pro-rata calculation based on all IRAs in existence at the end of the year of conversion.  If there’s no pre-tax IRA balance, at the end of the calendar year of conversion, the conversion is completely tax-free.

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.