Roth Conversion of an Individual Retirement Annuity
I have a Fixed Index Annuity with a Lifetime Income Rider in a Traditional IRA. After the income stream is initiated, the account value is decreased with each income distribution. The ILR continues to pay income even after the FIA account value goes to zero. If the FIA T-IRA is converted to a Roth IRA when the account value is low, taxable income is based on the fair market value of the annuity on the date of conversion. How is fair market value for a Roth conversion determined? IRS Bulletin 2008-38 appears to address this, and it offers several options. Paragraph A-14(b)(3)(ii) states “Future distributions are not to be assumed in the determination of the actuarial present value of additional benefits. I interpret this to mean the fair market value is restricted to the account value and does not include any assumed future income distributions possible due to longevity. Is this correct?
Permalink Submitted by Alan - IRA critic on Wed, 2015-03-11 00:10
IRS Regs for RMDs that apply to IRA annuities exempt many fringe benefits including death benefits in most cases from the determination of the RMD for the contract. However, IRS Bulletin 2008-38 was released after revelation of various annuity schemes to depress annuity values for purposes of lowering tax due when these IRA annuities were converted. Therefore, the bulletin disallows several of the exemptions allowed for RMD determination in determining the actuarial present value that will show up on the 1099R reporting the conversion. This means that the FMV of the same annuity will be higher for distribution purposes than it will be for conversion purposes. When determining the actuarial present value, the RMDs that would be due on the IRA annuity will reduce the present value as opposed to the same product in a Roth IRA without the RMD requirement. Of course, the insurer will also have other options to determine the FMV under the bulletin including comparable premiums for a very similar new annuity. Survival of the taxpayer well beyond expected mortality tables should not be reflected in the FMV. The determination of FMV is therefore complex enough such that anyone contemplating a conversion should request a FMV determination before converting. If the insurer does not wish to comply, they can be reminded that they are obligated to recharacterize the conversion should the taxpayer request for any reason including a higher than expected 1099R.