Thursday, October 28, 2010

RMDs, Roth Conversion Taxes Highlight Mailbag

This week's Slott Report Mailbag discusses some complex, timely issues involving RMDs and what happens if someone who takes a Roth Conversion with the intent of spreading the tax over 2011 and 2012 dies suddenly. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure.


If I have an IRA account and take no RMDs during my lifetime, will the beneficiaries of my account be penalized? If so what amount?

I tried to find the answer on the IRS site but was unsuccessful.

Thanks you so much!

If you have a traditional or inherited IRA and are subject to required minimum distributions (RMDs) and did not take them, then there is a 50% penalty, (50% is correct), based on the amount not taken or if none were taken on the entire RMD amount for each year missed. If you died without taking the RMDs during your life your beneficiaries of the IRA or your estate would be liable for the distributions and the tax on them, and the penalty. If you truly do not want to take the distributions, perhaps you should consider converting your IRA to a Roth IRA. However, all your RMDs would have to be taken before you could do a conversion. Also, keep in mind that the IRA custodians are telling IRS every year that you do have an RMD. At some point, they are likely to ask you why you have not taken them.


I could use a little more enlightenment on the third sentence of the article below. I also assume that one must still pay the income tax as ordinary income on the hypothetical $5,000 when taken out/transferred, correct?

Another tactic: Take your RMDs in securities, not cash, Pavese says. Suppose you have shares worth $5,000. Have your custodian do a transfer in kind into an ordinary taxable account.

Say the shares appreciate to $8,000 in five years. At that point you sell them.
The $3,000 appreciation will be taxed at the long-term capital gains rate. That would be either the present 15% rate or perhaps the higher, proposed 20% rate.

"Many people don't realize the new basis is the $5,000, not what you originally paid," Slott said.

If you had kept the stock in your IRA and withdrawn it in five years, it would be taxed at ordinary income rates, Pavese says. Even today, those go as high as 35%. President Obama has proposed lifting that to 39.6%. That's where it could be five years from now.

Yes, you are permitted to take a required minimum distribution (RMD) in kind. This means having the IRA custodian distribute shares of securities held in the account to you instead of cash. You will pay income tax on the fair market value on the day distributed from the IRA. Your cost basis for income tax purposes when you sell the shares is the market value on the day of distribution from the IRA. If you held the shares for a year or longer and then sold the shares for a higher value from the value upon distribution from the IRA you would pay a long term capital gain tax based on the rates at that time.

You would get the same result by taking cash for your RMD and then buy the shares at that time. Taking a distribution in kind can be very difficult, some custodians will not do it, taking the cash will avoid all the difficulties.


What happens if an individual who does a Roth Conversion in 2010 with the intention of spreading the taxes to 2011 and 2012 dies? Will they still be able to spread the taxes to 2011 and 2012? If not, is it possible to re-characterize to IRA after death?

Great question. If someone elects to spread the taxable conversion amount from the Roth IRA conversion over 2011 & 2012 and dies, the income tax due is accelerated to the year of death. All of the remaining income for the conversion is included on the final tax return of the decedent. The Roth regulations say that the executor of the estate can recharacterize but that must be done by October 15th of the year following conversion. However, this presents some practical problems if the executor and the beneficiary are not the same individual. There also may be an issue in naming a beneficiary on the IRA account the funds go back to and once the funds are back in an IRA the beneficiary cannot then reconvert them to a Roth IRA. Only an IRA owner can do a Roth conversion, not a beneficiary.

By IRA Technical Consultant Marvin Rotenberg and Jared Trexler
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