Life and Death Planning for Retirement Benefits

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242 Life and Death Planning for Retirement Benefits
computed for purposes of this now-obsolete test, see the Special Report: Ancient History
.
5.4.03 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
i 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 .
A. A Roth conversion is a “taxable rollover.” Under rollovers generally are
nontaxable. However, provides that “Notwithstanding”
“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
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:
 For conversions in 1998 or 2010, special “income spreading” treatment is allowed; see
 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 or for purposes of
computing the distributee’s income if the contract had been distributed and not converted
to a Roth IRA. Reg. A-14. For more on this rule, see 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 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. A-7(a). For how to determine
how much basis the participant has in his IRAs, see To determine much of any
particular IRA-to-Roth IRA conversion is treated as a tax-free conversion of the
participant’s basis, see 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
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.