Using a qualified plan account to fund a Roth IRA conversion.

• Author: Klahsen, Rick
• Position: Individual retirement accounts

Roth IRAs have become popular retirement savings options since their introduction in 1998. However, high-income individuals have not been able to take advantage of the Roth IRA opportunity. Recent tax law changes expand the Roth IRA to all taxpayers who have or could have traditional IRA accounts.

Background

Before 2010, the Code limited the opportunity to convert a traditional individual retirement account (IRA) into a Roth IRA to individuals with adjusted gross income of less than $100,000 (not indexed). In addition, the Code prevented all individuals with a married filing separately tax filing status from electing a Roth IRA conversion, regardless of their income levels. In 2006, Congress enacted the Tax Increase Prevention and Reconciliation Act, P.L. 109-222 (TIPRA), which prospectively repealed (effective January 1, 2010) both the $100,000 income limit for conversions and the restrictions applicable to taxpayers who are married filing separately. Therefore, as of January 1, 2010, all taxpayers are eligible to convert a regular IRA to a Roth IRA regardless of their filing status or income level.

The Roth Advantage

Unlike traditional IRA accounts, qualified distributions of the earnings in a Roth IRA account are free from federal income tax (see Sec. 408A(d)). In addition, Roth IRA accounts are, during the IRA owner's lifetime, not subject to the required minimum distribution rules of Sec. 401(a)(9) (A) (see Sec. 408A(c)(5)). A spousal beneficiary of a Roth IRA can continue to defer the distribution of the account (see Sec. 401(a)(9)(B))(iv)). Nonspousal beneficiaries of a Roth IRA will have to begin distributions after the participant's death (see Sec. 408A(c)(5)). The price a taxpayer pays for the tax-free distribution and the extended period of tax-free buildup of assets is that the taxpayer must fund current-year Roth IRA contributions with after-tax money and must pay tax on Roth IRA conversion transactions.

Types of Retirement Accounts Eligible for Conversion

A taxpayer may elect a Roth IRA conversion of a traditional IRA or may convert an eligible rollover distribution as defined under Sec. 402(c)(8). Plans eligible for rollover include qualified plans such as pension, profit sharing, or 401 (k) plans; 403(b) annuity plans; and governmental Sec. 457 plans. A taxpayer may also convert a SEP IRA or SIMPLE IRA. However, a SIMPLE IRA is not eligible for conversion until the applicable two-year period under Sec. 72(t)(6) expires: A 25% premature distribution penalty applies to any distributions made before the SIMPLE IRA participant has either completed two years of participation or reached age 591/2 (see Regs. Sec. 1.408A-4, Q&A-4).

The Problem

TIPRA's expansion of the conversion opportunity is a welcome change. However, many high-income individuals do not have IRA accounts...