The Roth IRA - what a great deal!

• Author: Franklin, Richard S.

This article explains statutory requirements of the Roth IRA, some issues that are not addresses or are unclear in the new statute, and possible planning to strategies to take advantage of the Roth IRA.

The new Roth IRA(1) allows a taxpayer to fund an IRA with amounts ranging from just a few thousand to millions of dollars, lets the funds grow tax exempt for a virtually unlimited period of time, and allows the taxpayer to withdraw the moneys tax free. The most significant features of the new Roth IRA, which distinguish it from a traditional IRA, are that i) distributions are not required during the owner's lifetime, and ii) when taken, distributions are tax free, as long as the account has been in existence for five years and the distributions are taken after age 59 1/2.

This article explains the technical statutory requirements of the Roth IRA, some issues that are not addressed or that are unclear in the new statute, and some possible planning strategies to take advantage of the Roth IRA.

How to Fund the Roth IRA

There are two ways to find a Roth IRA. First, the taxpayer may make nondeductible cash contributions to a Roth IRA.(2) Second, the taxpayer may convert (roll over) assets in a traditional IRA to a Roth IRA. Although funding a Roth IRA through contributions may benefit the taxpayer, the "real deal," from an estate and income tax perspective, comes from the rollover; thus, this article will primarily discuss the rollover provisions.

Rollover Requirements

The ability of a taxpayer to roll over a traditional IRA to a Roth IRA is only available if the taxpayer's adjusted gross income (AGI) is not greater than $100,000 (the AGI threshold) and the taxpayer is not married filing separately.(3)

* The AGI Threshold

For purposes of the Roth IRA, AGI is defined the same as it is defined under IRC [sections] 219(g)(3), except the amount required to be included in income as a result of the conversion to the Roth IRA is not counted toward the $100,000 threshold.(4) In general, it is the amount that the taxpayer reports on line 32 of his or her Form 1040, personal income tax return.

* How to Plan to Meet the AGI Threshold

If a taxpayer normally has annual AGI in excess of $100,000, he or she may want to consider planning in this taxable year such that the AGI is under the threshold. For example, the taxpayer could consider converting taxable interest income to nontaxable interest income through investing in tax-free bonds, recognizing capital losses, or deferring income, if possible.

Problem with Taxpayers in Pay Status

One of the unanswered issues deals with the situation where the taxpayer is already in pay status (that is, the taxpayer is beyond his or her required beginning date (RBD)).(5) The issue is clearly seen by this example.

Let's suppose that the taxpayer, T, is in pay status, has a $2 million traditional IRA, in which his minimum required distribution (MRD)(6) for 1998 is $110,000, and has no other taxable income.

The question to be addressed is whether T is permitted to roll over any part of or all of the MRD of $110,000. If the rollover is permissible, then arguably the amount that is rolled over should not be counted toward the AGI threshold. However, if the MRD could not be rolled over, then it would be included in T's AGI; thus, he would not meet the $100,000 limitation.

From a pure statutory analysis, it appears that the MRD from a traditional IRA cannot be rolled over. IRC [sections] 408A(a) provides that "[e]xcept as provided in this section, a Roth IRA shall be treated for purposes of this title in the same manner as an individual retirement plan." What this means is that the rules under [sections] 408 applicable to traditional IRAs apply to Roth IRAs, unless indicated otherwise in [sections] 408A. Section 408A(c)(3)(B) permits a taxpayer to make a "qualified rollover contribution" if two requirements are met, as stated below. Section 408A(e) defines a "qualified rollover contribution" as a rollover contribution to a Roth IRA from a traditional IRA,(7) provided that such rollover contribution from the traditional IRA meets the requirements of [sections] 408(d)(3). However, [sections] 408(d)(3)(E) specifically prohibits the rollover of the minimum required distribution. Essentially: i) [sections] 408A does not specifically authorize the rollover of the MRD; ii) [sections] 408A defers to [sections] 408 for rules not otherwise covered in [sections] 408A; and iii) [sections] 408(d)(3)(E) specifically prohibits the rollover of the MRD. Therefore, the argument goes that the MRD will not be considered a qualified rollover contribution for purposes of [sections]...