Calculating RMD’s
In the general situation, plan participants calculate RMD’s by using prior year end IRA and QRP balances and divide by the applicable Uniform Table factor to determine that year’s RMD. Is any adjustment made if the prior year end IRA or QRP balances contain after tax contributions? If no offset is made, then resulting RMD’s would seem to contain some return of after tax contributions. Is it advisable to convert the after tax component to a Roth IRA thereby reducing future RMD’s and pay tax on only pre-tax contributions?
Mike C
Permalink Submitted by Alan Spross on Wed, 2009-09-09 01:52
Mike,
The amount of after tax basis in a plan year end balance does not change the amount of the RMD, however it will result in a portion of that RMD being tax free using a pro rate factor. Form 8606 is used to report and calculate this for IRA RMDs. For QRPs, the employer should show the proper taxable amount on Form 1099R.
Conversion of either QRP or IRA balances to a Roth IRA can reduce future RMDs. There has been an on going debate about whether direct rollovers to TIRA and Roth IRA accounts from employer plans could direct all the pre tax amount to the TIRA and the after tax basis to the Roth IRA. Releases this week from the IRS (Notices 2009-68 and 2009-75) confirm that the pro rate rules apply to all distributions unless there are pre 1987 after tax amounts in the QRP. These pre 87 amounts can often be distributed separately from the remaining balance and go to the Roth IRA. It IS possible to separate the pre tax amounts from the after tax amounts if indirect rollovers are done and the employee does the rollovers themself, as there is a rule that states that employee rollovers are deemed to come first from the pre tax amount. The 20% withholding would have to be replaced to complete the rollover. The after tax balance could then be rolled over to a Roth IRA.
Whether you should actually do conversions or not depends on several variables. You would not want to convert at a tax rate that is higher than your expected marginal rate in retirement, but of course the latter number is an educated guess. There are many conversion calculators on the web, but none of them address all the variables that should be considered by an individual.