Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

Distribution (conversion) Amount: $50,000 Total Nondeductible Contributions: $40,000 Year-end Account Balance: $450,000 Outstanding Rollovers: zero Return of Basis = $50,000 X [$40,000 ÷ ($450,000 + $50,000)] = $4,000

The amount of gross income Ted must report is therefore $46,000 ($50,000 conversion minus $4,000 basis allocated to the conversion). His remaining basis in his traditional IRA is $36,000 ($40,000 total basis, less $4,000 used up in the conversion). 2.2.09 Partial rollovers and conversions: IRA distributions This section explains how basis is apportioned in the case of a partial rollover or partial Roth conversion of an IRA distribution. A. IRA-to-nonIRA plan rollovers. When a distribution from a traditional IRA is rolled over to a QRP or 403(b) plan, the rolled-over money is deemed to come entirely out of the taxable portion of the traditional IRA distribution. § 408(d)(3)(H) (applicable to years after 2001). This rule is necessary because the nontaxable portion of an IRA cannot legally be rolled into a QRP or 403(b) plan. ¶ 2.6.02 (H). See IRS Publication 590 (IRAs) (2009 edition, p. 23). This exception creates the opportunity for a tax-free distribution from a traditional IRA. In the Gibbs Example ( ¶ 2.2.08 (G)), if Gibbs participates in a QRP that accepts rollovers, Gibbs could take a total distribution of all his IRA balances, then roll over, to the QRP, every dollar above his $12,000 basis. Now he is left with just $12,000, outside any plan, all after-tax money. He can then keep this money outside the plan (thus effecting a distribution of his after-tax money while keeping all pretax money inside a plan), or he can roll the $12,000 into a Roth IRA, thus (apparently; the IRS has not commented on this technique) effecting a tax-free Roth conversion. B. Partial IRA to Roth IRA conversion. Generally, any IRA distribution consists proportionately of pre- and after-tax money, and the same is true for any transfer (conversion) from a traditional IRA to a Roth IRA. ¶ 2.2.08 . If the participant takes a distribution from his IRA, and the distribution contains both pretax and after-tax money, and the participant rolls over (converts) only part of the distribution to a Roth IRA, the rollover would apparently consist of the same proportions of pre- and after-tax money as the distribution itself. See Reg. § 1.408A-4 , A-1(b), (c), A-7(a); § 408(d)(1) , (2) ; compare § 408(d)(3)(H) ; IRS Form 8606 (2009). Unlike with the special rules applicable to partial rollovers of QRP distributions ( ¶ 2.2.05 (C)), and to IRA-to-nonIRA plan rollovers (see “A” above), there is no special exception to § 72 applicable to partial IRA-to-IRA (or IRA-to- Roth IRA) rollovers that would cause the pretax money to be deemed rolled first. The only possible exception to this conclusion arises if the partial IRA distribution occurs in a year in which a minimum distribution is required. Reg. § 1.402(c)-2 , A-8, provides that, in the case of a distribution from a qualified plan , where the distribution includes both pre- and after-tax money, the after-tax money is applied first to the RMD for the year. This has the effect of making more of the pretax money eligible for rollover. It is not clear whether this same rule also applies to IRA distributions. 2.2.10 Exceptions to the cream-in-the-coffee rule for IRAs