Rollovers and Roth Conversions: Today’s Slott Report Mailbag

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Question:

To whom it may concern,

Quick question.  Client’s daughter died at age 41. Client is age 71.  Can she combo her daughter’s 401k into her current Traditional IRA since she has to take RMD’s on the traditional and a Beneficiary/Inherited IRA would be based on her (Mom’s 71) current age for Beneficiary/Inherited RMD’s, OR does she have to open a Beneficiary/Inherited RMD no matter what and a combo of Traditional IRA and Beneficiary/Inherited IRA is not allowed.   Any help would be appreciated. Love your articles in FA.

Thanks,

Collin

Answer:

Hi Collin,

The rules are very clear. Your client can directly roll over her daughter’s 401(k) into an inherited IRA. She would then take required minimum distributions (RMDs) from this inherited IRA. The inherited IRA must be kept separate from her own IRA. The two accounts cannot be combined.

The RMDs from the two accounts will be calculated differently. To calculate the RMDs from the inherited IRA, she will use a factor from the IRS Single Life Expectancy Table. To calculate the RMDs from her own IRA, she will use a factor from the IRS Uniform Lifetime Table.

Question:

Not sure if you can help….but I have what I think is a somewhat simple IRA tax question/situation. My financial advisor converted $20K from a traditional IRA to my ROTH IRA back in 2017. Since I’m retired, I’m also getting $1800/month (pre-tax) from a traditional IRA.($21,600/yr). I’m also getting premium subsidies from OBAMACARE for my medical insurance (about $5K). What I found out was that because of the $20K conversion to a ROTH IRA…that almost doubled my taxable income…putting me 4X over the “poverty limit” for Illinois and making me ineligible for the healthcare premium subsidies….and I had to payback the $5K premium subsidy I had on my Federal tax return. (I have an extension until Oct. 2018 to file)

After I told my advisor, he “recharacterized” the $20K IRA conversion in April 2018. I thought this would drop my 2018 gross income to about $30K and I wouldn’t have to pay back the healthcare subsidy. I even tried to work this out on my 2017 tax return using “paid advice” from the TURBO TAX people…but while attempting to fill out the forms I hit a roadblock when TT software said I couldn’t move the $20K back to a regular IRA since I had no (zero) “earned” income…  and you can’t “contribute” more to an IRA than you “earned”?? I’m not sure why the “recharacterization” of the original $20K ROTH IRA conversion counts as a normal contribution…which it isn’t (?). My total IRA balances didn’t change.

Thanx for any help/response.

Answer:

Your situation is a common one. Converting a traditional IRA to a Roth IRA results in a tax bill and it can also affect eligibility for other government programs, subsidies, or even tax breaks. You are in luck that 2017 Roth IRA conversions can be recharacterized until October 15, 2018. This opportunity for a “do over” will not be available for conversions done in 2018 or later. Therefore, if you are going to do another conversion in the future, make you sure you understand how that additional income will impact your eligibility for other programs and credits prior to pulling the trigger.

When you recharacterize a conversion, for tax purposes it is treated as though it never happened, and the tax bill is wiped away. The recharacterization of the conversion is not treated as a tax year contribution and there is no requirement to have earned income to complete a recharacterization.

Handling a recharacterization of a conversion on the tax return is complicated. This may be a time where you may want to seek advice from a tax professional.