IRAs: RMDs and Conversions to Roth IRAs -- A Fabulous Year-End Door Opener!

Posted by Bob Burton on Mon, Dec 7, 2009 @ 04:11 PM

Here are two timely subjects that should enable you to contact your clients before year-end.

Required Minimum Distributions. Traditional IRAs are all subject to the Required Minimum Distribution (RMD) rules once the IRA owner reaches age 70½ ... EXCEPT FOR THIS YEAR. DUE TO THE CURRENT ECONOMIC CLIMATE, RMDs HAVE BEEN SUSPENDED FOR THE YEAR 2009. Most of your clients probably know this, but a reminder from you could stand you in very good stead. Even if a client has already taken a RMD this year without knowing that the requirement has been suspended, it probably occurred fairly recently, so if the RMD was taken less than 60 days ago, it can easily be reversed if desired by rolling it over to a different IRA.

Conversions to Roth IRAs. There are basically only two types of IRAs: traditional IRAs (a tax-deferred environment) and Roth IRAs (a tax-free environment, provided certain rules are met). Beginning on January 1, 2010, the $100,000 “modified adjusted gross income” limitation on the ability to convert a traditional IRA to a Roth IRA will no longer apply. This opens up powerful new planning opportunities for anyone who has a traditional IRA.

The conversion of a traditional IRA to a Roth IRA is a taxable event, but thereafter everything in the Roth IRA, including distributions, will be income tax-free, provided some simple rules (discussion of which is beyond the scope of this blog post) are complied with. Although some clients may conclude that, because of the current income tax consequence, a conversion is not beneficial in their situation, we believe that every IRA holder should at least give it very serious consideration for the following reasons:

1. Timing of the tax payable. The automatic rule for paying income tax on a conversion made in 2010 is 1/2 payable for the tax year 2011 (which means as late as October 15, 2012, with a tax return filing extension) and 1/2 for the tax year 2012 (which means as late as October 15, 2013, with a tax return filing extension). The automatic rule can be altered by making an election on the 2010 return to pay the tax for the tax year 2010 -- but both that election and the payment of the tax can be deferred to October 17, 2011 (October 15 is a Saturday), with a tax return filing extension. In other words, there is a large degree of flexibility here.

2. Ability to “recharacterize” (i.e., undo) the conversion. The law provides that a taxpayer who implements a conversion to a Roth IRA during 2010 has until the taxpayer’s 2010 return is due and timely filed (including extensions, i.e., as late as October 17, 2011) to change his or her mind and have the Roth IRA changed back to a traditional IRA. The decision whether or not to do this could well depend on whether the value of the converted assets has increased (probably stick with it) or decreased (reverse it).

The most likely sale that we can help you with in this area involves annuities, either deferred or immediate. Remember, in a Roth IRA, everything, including distributions, should be tax-free rather than just tax-deferred. Tax-free income is always welcomed with open arms!

For more information, please contact Provada at 415-369-9990.