Taxpayer asks:
Hi,
I am currently retired, age of 60.
I have pension income of $48K / yr and investment income of 20K/ yr.
What are the tax consequences of converting a 401k of $120K to a Roth IRA?
To limit taxes, should the conversion be structured over several years?
Thanks,
Taxgirl says:
Retirement planning is so not my forte. So I’m gonna tell you the tax consequences of your transaction – but I’m not going to advise as to whether it makes sense for you or not. I would strongly advise that you check with a retirement or financial planner to make sure that this is the best option for you.
This is the scoop. As of last year, you can roll over a 401(k) into a Roth IRA. When Roth IRAs were originally conceived, this wasn’t something that was allowed.
Since Roth IRAs are funded with after tax dollars, the amount that you roll over is subject to federal income tax. Specifically, any amounts that would have been taxable had you simply pulled out the funds and not funded the Roth IRA are reportable as gross income.
You’re under the income limit for making the rollover – though that will not matter in 2010. In 2006, President Bush signed a bill that changed the eligibility rules for Roth IRA conversions. For 2010 (and so far, only for 2010), taxpayers with modified adjusted gross income of more than $100,000 can convert qualified retirement funds to a Roth IRA. Additionally, for 2010, income tax due on conversions can be spread included as income and paid in 2011 and 2012. This can be a great help, assuming that you remember to put aside enough money to pay the tax bill in those years.
The advantage, of course, is that after all is said and done, future distributions from the Roth IRA are income tax free.
There are some other conversion, limitations and ordering rules that you should familiarize yourself with before making the decision to make the roll over. You may wish to take advantage of that 2010 exclusion – so don’t rush into anything. Find someone who knows what they’re talking about and can run the numbers for you for comparison. Roth IRAs can be great vehicles but they’re not for everyone.
Like any good lawyer, I need to add a disclaimer: Unfortunately, it is impossible to give comprehensive tax advice over the internet, no matter how well researched or written. Before relying on any information given on this site, contact a tax professional to discuss your particular situation.
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Just before the holidays, President Bush signed a bill that eliminated the hefty penalty for not taking the required minimum distributions (RMDs) from certain tax-deferred retirement accounts such as traditional IRAs and 401(k) plans for the year 2009.
Under the traditional rules, you must begin RMDs for traditional IRAs and 401(k) plans by April 1 of the year after you reach age 70-1/2. In other words, the April 1 that follows your 70-1/2 birthday is the first day that you must take a RMD. The amount of the RMD is calculated by your life expectancy – you can figure it out yourself using the tables from the IRS but it’s usually much easier to have your financial advisor do it (they have fancy software). This amount is recalculated each year since your life expectancy changes each year. You can always take out more than the RMD but you can’t take out less without being subject to a fairly significant penalty.
In 2009, however, you catch a break. You won’t be subject to the penalty if you choose (for whatever reason) to leave your money in your retirement account and not take the RMD. Note that this is NOT applicable to 2008, 2010, or any other year – just 2009. Congress likes to do quirky things like that.
Of course, there are some complications. If you were required to make your first RMD in 2008 and chose to push it off until the April 1, 2009 deadline for newbies, you must still take your RMD. You wouldn’t be exempt under the new rules since it’s technically a 2008 obligation.
If you turn 70-1/2 in 2009, you won’t be required to make your first RMD in 2009. You will, however, have to make a 2010 withdrawal by the end of 2010 (assuming that the rules don’t change). It’s odd, but under the new rules, the 2010 withdrawal will be considered your “second” distribution by the IRS even though it’s really your first. So you don’t get to take advantage of the “extension” through April 1, 2011 – you have to take it by the end of 2010. I know. It’s weird. But there you go.
Similarly, if you inherit an IRA and you are required to take a RMD in 2009 under the 5 year rule, you can skip 2009 – if you want to.
Remember, these rules don’t mean that you can’t take out your RMD, just that you don’t have to – and it only applies to 2009.
And one more thing: I don’t want to play financial advisor – because I’m not. But I do know a thing or two about taxes. And with changes in the rules, there are investment folks who, having taking a beating in the market over the last year, may see this as an opportunity to sell you a Roth IRA.
I think Roth IRAs can be wonderful investment vehicles under the right circumstances. Shifting tax brackets – paying lower taxes now on the Roth to avoid higher taxes later – can work to your advantage. But, in the case of many (though admittedly not all), the tax bracket for retirees remains relatively flat, so there may not be a benefit to paying now. Roth IRAs can also be good if the period of time for tax free withdrawals is significant – not always the case for retirees who have already reached age 70-1/2. It’s also not optimal if you have to pay tax on the distribution out of the funds that you’re contributing to the Roth.
So, a conversion under the new rules may be a good idea but don’t assume that it is. Be smart. Ask questions. Run numbers.
Finally, there’s been some chatter that this RMD penalty exemption may be extended past 2009. For now, it’s just chatter, so don’t count on it. As of today, the only year for which the penalty is eliminated for not taking your RMD is 2009. Traditional income tax rules as they relate to distributions still apply.
Taxpayer asks: I had a IRA from a former employer that was rolled over to a brokerage account in 2006. While preparing for my tax appointment, I contacted the brokerage house to find out if I was due a 1099 as I hadn’t received one. They said no. So I went to my appointment, got my taxes done and off they went to the IRS. On Monday of this week, I received my 1099 from my former employer (it was a general board of pension 403b account that manages their own funds), apologizing that they didn’t send it to me when they were supposed, citing a glitch in their system.
So my question is…I’ve received no gains, everything I had was rolled-over. I’ve already submitted my taxes for 2006. Do I need to amend anything and how can I strangle the general board that had managed my 403b 
I haven’t been able to get in touch with my tax adviser, so I hope you don’t mind the question, especially given it’s a busy time for all tax professionals.
Thanks so much!
Taxgirl says:
Internal Revenue Service rules for IRAs generally require traditional IRA account holders to wait until age 59 1/2 to make a withdrawal with no penalty. If you withdraw prior to age 59 1/2 and qualify under an exemption for the penalty, you are likely still required to report the distribution as income. However, there are circumstances when you can make a "withdrawal" from one plan and not have it qualify as income or be subject to penalty. The most common example is if the "withdrawal" qualifies as an administrative rollover (meaning it was merely transferred from one financial institution or plan to another). In an administrative rollover, at no time should you have control over that money, meaning no checks written to you – you never touched the money. Get it? In that case, there should be no tax consequence to you.
If this was intended to be an administrative rollover, I would:
1. Double-check your 1099-R to make sure that the rollover is properly noted; and
2. Assuming that it is, amend your return to show the receipt of the 1099, but that it’s not taxable income, and send your 1099-R with the amended return to IRS.
You could just let it go but the IRS requires that you send forms 1099-R to them so a clerk somewhere is going to see the 1099-R from your employer and wonder why it wasn’t reported on your end. You don’t want to trigger an unnecessary investigation into your tax return. A lot of hassle for no change.
Sorry to hear it!
Good luck.
Like any good lawyer, I need to add a disclaimer: Unfortunately, it is impossible to give comprehensive tax advice over the internet, no matter how well researched or written. Before relying on any information given on this site, contact a tax professional to discuss your particular situation.
One of the most important tax changes for 2006 is the increase in the contribution limit for Roth and traditional IRAs rises for those taxpayers who are aged 50 or more. The increase is more than 10% from $4,500 to $5,000. But if you’re under age 50, sorry, the contribution limits remain the same.
Even more impressive, phase-outs for IRA deductions also rise about 10%, beginning now at $75,000 if married filing jointly. There’s no change for single persons or heads of households (still $50,000) and $0 for a married person filing a separately.
Contribution limits for employees who participate in 401(k), 403(b) and other retirement plans have risen to $15,000. For SIMPLE plans, the limit remains at $10,000.
