ROTH CONVERSIONS AFTER 70½:
SOME SENIORS FACE OBSTACLES

By Edward A. Slott

major problem has developed for some IRA owners who have passed their required beginning date (RBD). The RBD is the April 1st after the calendar year in which a taxpayer turns 70½ years old. This is the date that mandatory distributions from IRAs must begin.

As a review, a traditional (old-type) IRA may be converted to a Roth IRA if the taxpayer's income does not exceed $100,000 in the year of conversion. The $100,000 limit is the same for married-joint and single filers. Taxpayers cannot convert if they file married-separate. Regular income tax is payable on the amount withdrawn from the regular IRA and converted to the Roth IRA, but no penalty is due for early withdrawal if the taxpayer is under 59½ years old. Under a special provision in the tax law, conversions made in 1998 can be spread over four years by reporting one-quarter of the distribution on each of the next four years' tax returns, beginning with 1998. Any amounts withdrawn from the regular IRA and converted to a new Roth IRA do not count toward the $100,000 limit. If the assets withdrawn from the regular IRA are not or cannot be placed in a Roth IRA, they will not only be taxable as they would if they had been converted, but also will now count toward the $100,000 eligibility limit for the conversion. Herein lies the problem. Certain senior IRA owners who have passed their RBD cannot convert because of the required annual distributions.

The Problem: Required Distributions Cannot Be Converted to Roth IRAs.

Required minimum distributions cannot be rolled over. This means that they cannot be converted to a Roth IRA. As a result, required distributions will count toward the $100,000 Roth conversion eligibility limit. For some seniors in this position, this will mean they cannot convert any of their IRAs to Roth IRAs. The following example illustrates the problem.

Example. An IRA owner is 75 years old, has an $800,000 IRA, and has been taking required minimum distributions of approximately $50,000 per year. His AGI, not counting the $50,000 required minimum distribution, is $80,000. If not for the $50,000 distribution, he would be eligible to convert the balance ($750,000) or any part thereof to a Roth IRA if he wished to do so. But he cannot! The tax regulations specifically state that a required distribution cannot be rolled over. If the $50,000 cannot be rolled over, then it must be added to his AGI for the $100,000 eligibility rule. This would bring his AGI to $130,000.

Here is another twist to the same problem: Let's change the example by using an IRA owner who will turn 70 ½ years old in 1998.

She is in the same situation, except that she is not required to take her first distribution until April 1, 1999. She does not have to withdraw at all from her IRA during 1998, if she does not choose to. If she did take the required distribution of $50,000 in 1998, it would put her over the $100,000 limit. She feels that, since she does not actually have to take this required distribution until April 1, 1999, she would qualify for the conversion in 1998. Sounds logical, but that is not the IRS's position.

Two Possible Answers

Position 1. This is the more conservative approach being taken by some financial institutions and is based on the proposed IRS regulations that cover rolling over a required distribution. The position is that if any part of the IRA is converted during 1998, the first dollars would be "deemed" the required distribution and will not be able to be rolled over. This would force the required distribution to be included in 1998 AGI for the $100,000 conversion test, even though there was no intent to take a required distribution until April 1, 1999.

Using real numbers from the example, if the 70 ½ year old attempted to convert $400,000 of her regular IRA to a Roth in 1998, some funds and banks are taking the position that the first $50,000 is her required distribution, which would make her ineligible for the Roth conversion. Remember, the $50,000 required distribution is already set in stone because it is based on the IRA balance at December 31, 1997; that amount can never be rolled over (converted) to a Roth.

The above position seems to go along with the proposed regulations and also happens to be the IRS's litigation position.

Position 2. The second possible answer that I am hearing from some is that you can take the minimum distribution by April 1, 1999, and that would leave you free to convert in 1998, assuming that your AGI otherwise does not exceed $100,000. The argument here is that the "deemed distribution" position just does not make sense. Of course, most tax law does not make sense.

The real question is: When is the distribution required? Is it technically not required until April 1, 1999, or is it required within the year of attaining age 70 ½ ? There may be arguments on both sides of the issue, but the IRS has let it be known that it is taking the position that the required distribution is due within the taxpayer's 70 ½ year (1998). And, if the first required distribution is not made until April 1, 1999, the first dollars of any 1998 conversion will be deemed the required minimum distribution, to the extent the required amount is satisfied.

Under position 2, there is no question that the entire IRA balance cannot be converted in 1998, leaving nothing for the required distribution in 1999. In the example above, the entire $800,000 IRA could not be converted, because we already know that $50,000 of that must be distributed by April 1, 1999, and that amount cannot be rolled over or converted to a Roth. There is no telling how tough or lenient the IRS will be with position 2.

Proposed New Legislation

On May 7, 1998, the Senate unanimously (97­0) passed the IRS Restructuring Bill which included Roth IRA technical corrections. One of the items in the bill would exclude required minimum distributions from counting toward the $100,000 AGI test to qualify for Roth IRA conversions. The provision, however, would not apply until 2005. This is no help to seniors who want to convert in 1998 and are precluded simply because of their required minimum distribution. *

Edward A. Slott, CPA, is the editor and publisher of Ed Slott's IRA Advisor, a monthly newsletter.