Life and Death Planning for Retirement Benefits

Chapter 5: Roth Retirement Plans

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computed for purposes of this now-obsolete test, see the Special Report: Ancient History ( Appendix C ).

Tax treatment of converting traditional IRA to Roth IRA

A rollover from a traditional IRA to a Roth IRA is generally treated, for income tax purposes, as a distribution from the traditional IRA. The term “conversion” is often used (including in § 408A ) for the rollover of funds from a traditional IRA to a Roth IRA, which is a taxable event, just as a handy way to distinguish that type of rollover from a “normal” rollover, which is nontaxable ( ¶ 2.6.01 ). A. A Roth conversion is a “taxable rollover.” Under § 408(d)(3) , rollovers generally are nontaxable. However, § 408A(d)(3)(A) provides that “Notwithstanding” § 408(d)(3) , “there shall be included in gross income any amount which would be includible were it not part of a qualified rollover contribution.” Thus, Roth conversions are taxable despite § 408(d)(3) . Whatever amount of a traditional IRA is converted or rolled over to a Roth IRA is taxed exactly as if it had been distributed from the traditional IRA and not rolled over, with the following exceptions:  If the converted property includes an annuity contract, the contract must be valued at fair market value for purposes of determining the amount of income includible by reason of the conversion, even if some different valuation method might have applied for determining the contract’s value for minimum distribution purposes ( ¶ 1.2.08 ) or for purposes of computing the distributee’s income if the contract had been distributed and not converted to a Roth IRA. Reg. § 1.408A-4 , A-14. For more on this rule, see ¶ 11.1.01 , Rule #3. So how are IRA distributions (and accordingly Roth conversions) taxed? Generally, all IRA distributions are taxable, but there are exceptions. For a catalogue of no- and low-tax distributions that are mostly not relevant to Roth conversions, see ¶ 2.1.06 . The one significant exception that DOES apply to Roth conversions is the rule that the participant’s own after -tax IRA contributions are not taxable when distributed to him (or converted to a Roth IRA); see “B.” B. Treatment of after-tax money in participant’s IRA(s). The amount converted from a traditional IRA to a Roth IRA is includible in the participant’s gross income except to the extent it is excluded from income as a return of the participant’s basis (investment in the contract); to that extent it is nontaxable. Reg. § 1.408A-4 , A-7(a). For how to determine how much basis the participant has in his IRAs, see ¶ 2.2.06 . To determine much of any particular IRA-to-Roth IRA conversion is treated as a tax-free conversion of the participant’s basis, see ¶ 2.2.08 – ¶ 2.2.10 . Someone with after-tax money in an IRA who also participates in a QRP that accepts rollovers, and who is therefore able to roll money from his IRA to his QRP account, can apparently follow the sequence described at ¶ 2.2.09 (A) to achieve a tax-free Roth IRA conversion of only the after-tax money in the IRA. Except for that sequence, there is no known way to convert only the after -tax money.  For conversions in 1998 or 2010, special “income spreading” treatment is allowed; see ¶ 5.4.05 .