Roth Conversion – Income
An over 70 1/2 client wishes to do a Roth conversion of an IRA. Inside the Roth, the client wishes to invest in a REIT paying a dividend. Once converted, how will this dividend income be viewed tax wise, if the client takes the income out of the Roth IRA as it is distributed? It has not been 5 years, but he is over 70 1/2.
Permalink Submitted by Alan Spross on Mon, 2011-01-03 23:37
An IRA distribution is taxed totally different than payment of income from a taxable account.
If this is client’s first Roth IRA account, it will not be qualified for 5 years. But any distributions of dividends or anything else are considered to have come first from his regular contributions, then from his conversions and last from earnings. Therefore, these payments are deemed to have come from his conversion amount and they are tax free. There is also no conversion 5 year holding period since he is over 59.5 and therefore no 10% penalty. Distributions are not considered earnings until he has withdrawn the entire amount of his contributions, and by that time his Roth will probably be qualified and that makes any distributions at all tax free. His Roth distributions must be reported on Form 8606 even though they would probably be tax free.
That said, if the client also did a 2010 conversion to a Roth IRA, taking any distributions prior to 2012 will result in accelerating the due date for his 2010 conversion.
Finally, note that client must take his 2011 RMD before doing any 2011 conversions. He cannot convert the 2011 RMD, but can convert additional amounts.