Traditional to Roth Conversions While Making Withdrawals under Rule 72t – possible?
Hello – I am 40 years old and am looking to use rule 72t to supplement my income, as I’ve accumulated a significant amount of money in my traditional IRA for my age. I’ve thoroughly researched the 72t rules and I believe I can successfully use it without busting the plan. I haven’t been able to find the answer to one question, though – can I do annual Roth conversions from the same traditional IRA account that I am making my equal 72t withdrawals from? Or would those conversion withdrawals bust the 72t plan?
Alternatively, I’ve thought about splitting my traditional IRA into two separate TIRA’s (assuming this is allowed) and doing the Roth conversions with one account and the 72t withdrawals with the other – but I would prefer to keep the assets in one account if possible.
Would appreciate any advice! Thanks.
Permalink Submitted by Alan - IRA critic on Thu, 2021-11-25 21:21
IRS Reg 1.408(A) QA 12 clearly indicates that a TIRA subject to a 72t plan can be converted to a Roth IRA without busting the plan. Taxable income for the conversion year would include the taxable portion of the conversion plus any other taxable amount actually distributed to the IRA owner to satisfy the annual 72t calculation. To be clear, part of your normal 72t distribution cannot be converted, just additional amounts since a 72t distribution is not eligible for rollover and a conversion is a rollover. Additional taxes for the conversion would be part of the annual expenses which the 72t plan was set up to pay.
The Reg is not clear about partial conversions, and you would probably not be well served by a total conversion. The IRS has busted plans in a couple cases for partial transfers, but those rulings are likely an aberration given the large amount of partial transfers that are done without issues. Your 1099R would include the total distribution including the conversion, and would therefore be larger than what the IRS is looking for, making it advisable to include an explanatory statement with your return regarding the conversion.
Obviously, 19 years is excessively long for a 72t plan, almost guaranteeing that the plan will not be ideal for that long a period of time. The greatest risk is that inflation or changing conditions in your financial landscape will require an increased distribution, and your only source for that money would be your IRA (either the remaining 72t TIRA or your conversion Roth IRA, which becomes a portion of your 72t plan). Exceeding the 72t amount would bust the plan, and if this happened after 15 years, the penalty and interest for all those years would be very large.
If you did convert some amount, you could choose which IRA type from which to complete your annual distribution, depending on how much you wish to be taxable that year. The 72t penalty waiver will also waive the 5 year conversion holding penalty for the conversions, therefore no 10% penalty at all regardless of which type of IRA you chose to satisfy your 72t distribution from. The IRS sees very few conversions, so this could attract attention to your plan which you would normally seek to avoid. This expected scrutiny from the IRS puts more pressure on you to not make any errors.
Your plan B to partition your IRA by direct transfers before the 72t plan begins into two or more IRA accounts would insulate your conversions from the 72t account. However, the smaller balance for the plan might not provide you with a large enough annual distribution without penalty, so this idea only works for those with a large enough IRA balance to exceed what is needed for the plan – or at least to have other income from non retirement investments, rentals, etc so that the 72t plan is only producing a portion of what you need to live on.