Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

Note that this five-year period is not the same as the Five-Year Period for determining “qualified distributions” ( ¶ 5.2.05 ). The latter begins in the first year any contribution is made to any Roth IRA; the former begins, as to any conversion of a traditional plan to Roth status, with the year of that particular conversion. Reg. § 1.408A-6 , A-5(c). Note also that this penalty applies even though the distribution is not included in gross income in the year it occurs. Rand Example: Rand, age 32, converted his $100,000 traditional IRA to a Roth IRA in 1999. He had no basis in the traditional IRA, so the entire $100,000 was includible in his gross income in 1999. He has no other Roth IRAs, and makes no other contributions to this one. In 2002, at age 35 ( i.e., within five years after the conversion, and while he is still under age 59½) he withdraws $20,000 from the Roth IRA. Under the Ordering Rules, this distribution is deemed to come out of the portion of the 1999 conversion-contribution that was includible in his gross income in 1999, and therefore it is subject to the 10 percent penalty in 2002. This special penalty rule that makes a conversion-contribution “off limits” for five years after the conversion does not prevent the participant from withdrawing (tax- and penalty-free) other contributions he has made (to the same or another Roth account) that are not subject to the rule: Leslie Example: In 2004, Leslie (age 40) converted a $100,000 traditional IRA to a Roth IRA. In 2009, when that Roth IRA had grown to $140,000, Leslie made a regular contribution ( ¶ 5.3.02 ) of $5,000 to the same account. In 2010, he does another conversion, transferring $50,000 more from his traditional IRA to the same Roth IRA that holds all his prior contributions and earnings. In 2011, the Roth IRA has grown to $210,000, and Leslie, now age 47, withdraws $15,000 from the account to pay the income tax on his 2010 conversion. Assume he does not qualify for any of the exceptions to the 10 percent penalty. Under the Ordering Rules ( ¶ 5.2.07 ), this distribution is deemed to come first from his 2009 regular contribution ($5,000), and the balance ($10,000) is deemed to come from his 2004 conversion contribution of $100,000. There is no income tax on this distribution, since it is deemed (under the Ordering Rules) to be coming entirely from his own already-taxed contributions; see ¶ 5.2.07 . There is also no penalty applicable to withdrawal of his 2009 $5,000 “regular” contribution, because the special penalty rule applies only to conversion contributions. Since the rest of his 2010 distribution is deemed to come from his 2004 conversion, which happened more than five years earlier, there also is no 10 percent penalty on the distribution of this “old and cold” conversion money. C. Penalty applies to failed conversion. A person who recharacterizes a Roth conversion (¶ 5.6) , then attempts to “reconvert” the same amount to a Roth IRA prior to expiration of the waiting period ( ¶ 5.6.07 ), has a “failed conversion” ( ¶ 5.4.06 ). His attempted reconversion does not qualify for the penalty exception applicable to successful Roth conversions. Reg. § 1.408A-4 , A-3(b) (last sentence).

Conversion while receiving “series of equal payments”

The 10 percent penalty does not apply to IRA distributions that are part of a “series of substantially equal periodic payments” (SOSEPP; see ¶ 9.2). Generally, qualification for the “SOSEPP” exception is lost (and a recapture tax imposed) if the series is “modified” prior to the date the participant attains age 59½, or, if later, the fifth anniversary of the first payment (yet another five-year rule!); see ¶ 9.3 .