Redemption of Recent Roth Conversion
Individual, age 89, converted his IRA to a Roth in November 2010 for a number of valid reasons, including a desire to pass the account on to his children and grandchildren income tax free. However, he has now entered a nursing home, and the family, acting legally on his behalf, now wants to cash in the Roth. This raises two issues:
1. If he dies this year, which is likely, is the total tax on the conversion due this year, or can the estate still report half the conversion amount this year and half next year?
2. Is there any penalty?
I’m sure I know the answer to this last question, but need it confirmed. I’m also sure these issues have been addressed before, so I apologize for bringing them up again, but thank you for your response to these.
Permalink Submitted by Alan Spross on Sun, 2011-05-22 19:08
Assuming there is no surviving spouse here, the 2010 conversion will have to be reported fully on his 2011 final return if he dies this year. If he lives until January, it can still be reported half in 2011 and half in 2012. If distributions are taken from the Roth IRA and attributed to the 2010 conversion but he lives past year end, the taxable income on the distributions taken will be accelerated from 2012 to 2011. (example, converted 500k normally reported 250 k each year; but 100k distribution is taken in 2011. That would change the income reporting to 350 in 2011 and 150 in 2012).
SInce a nursing home is fully deductible in excess of 7.5% AGI as a medical expense, perhaps recharacterizing enough of the conversion to be offset by medical deductions is a viable strategy. The tax bill for the conversion is erased and the nursing home expenses can be paid with a TIRA distribution that can be itemized off to a large extent.
There are also post death recharacterization options (10/17/2011 deadline), where executor has authority to recharacterize all or part of the 2010 conversion. There are no penalties involved in any of this, just income acceleration if Roth conversion funds are distributed this year and he survives 2011.
There are many flexible planning opportunities here, but they are date sensitive, and therefore a plan should be put in place now, and the executor briefed on the options and deadlines. Of course, the beneficiary designations on all IRAs should be very carefully reviewed under the circumstances.
Permalink Submitted by Sidney Poretsky on Sun, 2011-05-22 19:40
Thank you for the quick response. The indivdual IS married, and his wife is the primary named beneficiary. He is dying and not expected to live out the month. If the wife cashes in the Roth IRA next week and he dies right after that, can the tax on last year’s conversion be spread over 2011 and 2012? And if I understand your response, if SHE dies before the end of the year, then the whole tax would be due this year. Is that right? Interestingly, neither she nor her family care at all about the income or estate tax consequences of cashing in the Roth, or any of their other investments for that matter. I only asked about recharacterization in case there was any penalty, which it appears there isn’t.
Permalink Submitted by Alan Spross on Sun, 2011-05-22 21:36
No. While a sole surviving spouse can continue the two year deferral, that only applies to the conversion balance that has not been distributed prior to 2012. Cashing in the entire Roth will cause the entire conversion income to be reported in 2011 whether the owner passed or not. So if the owner cashed it in before passing or the surviving spouse cashed it in before 1/1/2012, the entire conversion tax would be due for the 2011 tax year, presumably on their joint return. And if both of them passed in 2011 with no distributions, then the entire conversion would also have to be reported in 2011.
There is no 10% penalty for not holding the conversion 5 years because that penalty ends at age 59.5 OR also if the Roth is inherited first.
Also, if the Roth owner has other Roth IRAs, balances prior to the conversion from regular contributions or older conversions are considered to be distributed before the 2010 conversion money. Therefore, taxation of distributions from the Roth IRA depends on whether all Roth balances were distributed vrs only a part of those balances. If the Roth is not qualified, any earnings are taxable when they are distributed, but earnings are probably very small.
Another option when he passes is for the surviving spouse to disclaim all or part of the inherited IRA. and the contingent beneficiaries will then inherit the disclaimed portion.
I am not clear on exactly why they want to cash in the entire Roth IRA. If they do that, they will have a large tax bill now, and all future tax deferral will be lost. Given that all of the parties may have different interests in this and only some of them have authority to act, this can get very complex. Would they have cashed in the TIRA if he had not converted it?