Roth conversion timing, account current value and tax payment timing

Submitted by Dave Bowman on Fri, 2018-03-09 13:25

I have an annuity with a lifetime rider that has a current value (2017 end of year) less than my original payment plus bonus, due to annual lifetime rider cost offsets. It only posts index interest every 5 years based on a positive index change plus a guarantee. The 5th anniversary is in October, 2018. If I declare this a Roth before October, do I pay on the “current value”, which is the end value as of Dec. 31, 2017 and reported to the IRS, or is it the end of 2018 value, which “could” be a bump of 50% or more once the index credits (it currently looks good, but could potentially disappear by the anniversary if the index drops). If it is the value at the time of the Roth declaration, then this has the best value of my annuities to convert first.

Also, can I wait to pay taxes on the 80.02% (100% less basis) of this conversion value until tax day in 2019 or do I need to make quarterly payments depending on the time of year the Roth declaration is made (September or early October in this case)? One other annuity anniversary is in late January, so if I convert this in a future year, owing taxes in April of the following year, does this require quarterly payments? I am retired and have paid zero taxes the last two years, as I am living purely on savings, CD interest and qualified dividends. I calculate my smallest conversion will be in excess of $35,000 in taxes, as only one of my annuities allows a partial conversion.

Thank you. My financial advisor just pointed me to your website, but I fear keyword searches on your blog that sometimes date back more than a decade may not be the correct current answer.



Submitted by Alan - IRA critic on Fri, 2018-03-09 18:09

  • https://www.investopedia.com/articles/retirement/10/rules-converting-ira-annuity-to-roth.asp
  • The above link explains that the taxable value of the conversion is determined on the date of conversion, BUT it will not necessarily be the current cash value. Disregard the final paragraph because you can no longer recharacterize the conversion, and therefore you need to request an indication of the value that will be reported on Form 1099R by the insurance company according to the valuation method they select.
  • If you have basis in your IRA documented on Form 8606, the taxable amount shown in Box 2a of the 1099R will be reduced by the basis recovery. All of your owned non Roth IRAs are factored in and for purposes of determining applied basis, the 12/31/2018 adjusted value of all your non Roth IRAs is used. Therefore, even if you get an estimate of what the 1099R will show, your taxable amount can still vary due the changes in your non Roth IRA total value up to year end. You can probably use the value of your other such annuities as reported on Form 5498 or statement of value, although the IRS Regs are not clear on that point. 
  • There are even different rules for determining the year end value for RMD purposes, once you reach 70.5. I think generally that your imputed value would be higher for conversion purposes than it would be for RMD purposes. Tax planning will be a challenge since you have to depend on these companies to provide you with the figures you need for conversion value as well as basis application on Form 8606.
  • Be sure to reject any withholding from your conversion distribution. The simplest method is to pay quarterly estimates based on your safe harbor of 100% of the prior year tax liability, so for the first year you do not have to pay any estimates as your prior year had 0 tax liability, although you will have a large tax bill in April. Remember not to convert so much that your marginal rate on the conversion will be higher than you expect to pay in retirement (unless the quoted value of the conversion comes in considerably lower than you expect the index adjustment to be).

Submitted by Dave Bowman on Sat, 2018-03-10 04:37

Thanks for the link and further info.All seven annuities are valued by the accumulation method and this is what is reported each year to the IRS. They are all fixed index annuities. So do I still need to request a value for Roth conversion? It seems this method is already accepted and may amount to the same number.I was unaware that my basis was from the end of the year following conversion vs. the start of the year (time of the conversion), so my current 20% basis may drop slightly If I convert my first Roth in 2018. I see that now, looking at f8606, which I have never filled out before.One more question: once an annuity is converted in full, are all future payments from that particular Roth/insurance company tax free? For instance, if I converted annuity A to a Roth and annuitized it first, is it tax free, or do I pay taxes using my basis in other annuities? (Would this be considered cherry-picking an annuity, such that only a percentage of my future payments from every annuity whether Roth or other, are tax free based on ratio’s of Roth, basis and pre-tax?)

Submitted by Alan - IRA critic on Sat, 2018-03-10 23:30

  • The accumulation method used to report the year end balance for RMD purposes differs from the calculation for conversion purposes. Exemptions for fringe benefits do not apply for conversion purposes which means the taxable amount on the date of conversion will be higher assuming the cash value did not change. You should therefore get a quote on what the 1099R would show for a conversion done on the date that the quote was calculated.
  • Strangely, the IRS has never released guidance on how 8606 basis should be applied when any owned IRA has been annuitized, since there is no longer an account balance after the principal has been surrendered to the insuror in exchange for a cash flow. You would have to improvize, perhaps using the year end value equal to the conversion 1099R less the annuity payments already made for the year for line 6 of the 8606. I doubt that the IRS will question how you came up with this figure,  but you should maintain the same procedure year after year. Again, this refers only to basis recovery on the conversion itself. 
  • After the contract has been converted, the Roth IRA ordering rules apply untll your Roth IRA is qualified. Until it is, your Roth IRA accounting must include all your Roth IRAs, and regular contributions come out first, then conversions starting with the oldest. In most cases, your Roth would be qualified before any Roth gains are distributed, so everything would be tax free, but you have to report Roth IRA distributions on Form 8606 until your Roth is qualified (5 years plus 59.5). IRA taxation rules trump all annuity taxation rules, and all your IRAs of the same type are factored into determining the taxable amount. 
  • There are several variables here such as lack of clear IRS guidance on basis recovery, insurance company calculation methods which can vary. In addition, there is no way to check their calculations unless they will provide you with worksheets.
  • https://us.eversheds-sutherland.com/portalresource/lookup/poid/Z1tOl9NPluKPtDNIqLMRV56Pab6TfzcRXncKbDtRr9tObDdEtWpCp0!/fileUpload.name=/IRSandTreasuryFinalizeRegulationsforValuingAnnuitiesinRothConversions.pdf

Submitted by Dave Bowman on Sun, 2018-03-11 01:14

Thank you again for making the dirty water just slightly less muddy! I will request conversion values on all my annuities, which might help determine which is best for the first year.

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