Roth conversion using 72(t)

Submitted by Epaenetus Joy Kapadia on Fri, 2019-09-13 19:14

Hi, I want to convert my IRA to Roth but I want to use 72(t) rule. I have read some where in Ed Slott book that you can kill two bird with one stone, when you use 72(t) rule 1) you avoid the 10% penalty. 2) you can use part of the 72(t) distribution to pay tax and can convert to Roth Ira, you don’t have to have extra cash on hand to pay the tax for roth conversion.
I called my IRA account holder (fidelity) and they told me you can not convert to roth and pay conversion tax using 72(t). you only can save penalty.
so please some one explain in detail how should I do it and kill two birds or provide me name of any expert to is willing to help me with this. I am willing to pay any fees.

Thank you.

Jk.



Submitted by Alan - IRA critic on Sat, 2019-09-14 02:33

  • Yes, you can convert your 72t plan TIRA to a Roth IRA, but it is very rare and therefore has a high chance of attracting IRS attention due to the 1099R amounts, the 8606 reporting the conversion, etc. There are also plenty of execution pitfalls in accomplishing this properly. As Fidelity has proven, very few in the industry or the IRS understand this transaction. The IRS Regs explain conversion of 72t plans in QA 12 of the following IRS Reg.
  • https://www.law.cornell.edu/cfr/text/26/1.408A-4
  • That said, on a few occasions the IRS has busted a 72t plan for a PARTIAL transfer, so if you are planning on converting only a portion of the 72t TIRA balance to Roth, there is more risk than converting the entire account. Of course, a total conversion is going to spike your marginal tax rate unless you have major offsets, another reason why this is rarely done.
  • You must still distribute to yourself the 72t calculated amount IN ADDITION to the converted amount, and this can be done in any combination between the TIRA and Roth IRA (must be a new Roth account) which becomes a portion of your 72t plan. For example, if you complete the 72t distribution from the Roth IRA after the conversion, it will not be taxable or subject to the conversion 5 year holding period due to the 72t penalty exception. That would leave only the conversion itself as taxable, not the conversion and the 72t distribution combined, but the conversion will be many times the value of the 72t distribution.
  • How you pay taxes is your call, as well as how your spend your 72t distributions. Taxes are just another expense you must pay, so less will be available for living expenses.Withholding from a 72t distribution is another moving part, and for these plans simplicity is best. Therefore, most 72t plan participants pay their taxes with quarterly estimates or perhaps withholding from other income sources than the IRA.
  • You must have a unique reason for asking this, such as a year of major deductions or NOLs where the conversion would not increase your tax rate, and you would then benefit from fewer taxable distributions in the future. I would not recommend conversion of your 72t IRA unless the numbers are very compelling.

Submitted by Epaenetus Joy Kapadia on Mon, 2020-02-10 14:12

Alan, what is NOL or  stand for?

Submitted by Alan - IRA critic on Mon, 2020-02-10 17:18

Net operating loss. See IRS Pub 536. Unlikely you would have a NOL unless you closed down a business with heavy losses or sustained losses in a federally declared disaster.

Submitted by David Mertz on Sat, 2019-09-14 13:33

  • I had some difficulty understanding what was being asked in the question here and perhaps the Fidelity rep had similar difficulty, resulting in some miscommunication.  One thing you are not permitted to do is to convert the 72(t) distribution itself to Roth because a 72(t) distribution is not eligible for rollover.  The 72(t) distribution can just be the source of funds needed to pay the tax on the Roth conversion of other amounts.
  • Except under exceptional circumstances, it seems unlikely that a single 72(t) distribution would produce enough funds to cover all of the increase in tax liability resulting from the Roth conversion of the entire TIRA that is under the 72(t) plan.  There might be a better chance of covering the increase in tax liability by using the 72(t) distribution for the year of the Roth conversion plus the 72(t) distribution for the following year, but it’s still questionable.  Presumably one would consider doing a Roth conversion that resulted in additional tax liability only if the existing 72(t) distributions were no longer needed for living expenses.

Submitted by Alan - IRA critic on Sat, 2019-09-14 15:45

You might look at the justifications for a conversion within a 72t plan as falling somewhere in a range of circumstances. At the high end, the conversion is compelling because large deductions or NOLs will allow a considerable amount of TIRA dollars to be converted at little additional tax cost.  At the low end, you are only considering the conversion because you do not need the the distributed funds required for your plan for current needs. In this scenario, you might simply make the one time switch to the RMD method rather than converting. Of course, you are more likely to fall somewhere in the middle of this range of conversion desirability.

Submitted by Epaenetus Joy Kapadia on Sun, 2019-10-13 12:38

 Hi Alan,Thanks for reply and sorry for delay. Thank you for reply to my post.First of all I do have very strong reason to use 72t to convert to roth. I can’t disscuss it in open forum. Is there a way we can speak offline? And I really want to do conversion and with the use of 72t.please let me know if we can talk or I can email you offline.thank you.Jk

Submitted by Alan - IRA critic on Sun, 2019-10-13 15:30

Sorry, but I restrict analysis to these public forums. Would be glad to continue here if you have further questions. However, I have no way of knowing if your conversion would draw extra scrutiny or not. There are so few of these, it is just the luck of the draw and which examiner reviews your return if flagged by IRS software. 

Submitted by Bruce Steiner on Sun, 2019-10-13 20:03

  • The issue is whether the proposed transaction makes sense.  You would be withdrawing money from your IRA before you had to.  It might be better to wait until you have to take distributions, and then use the portion of your required distributions (after income taxes and living expenses) to cover the income tax on some Roth conversions.
  • Bruce Steiner, attorney

Submitted by Epaenetus Joy Kapadia on Sat, 2019-12-28 16:37

Alan, Bruce,  Thank you guys for your replies and sorry for slow responce. First, Alan I did not understand your responce from sat 2019-9-14. Second, I have 11 years to retire( i am 51). when i retire I will recieve monthly pension and with my social security and my spouse’s social security,  will still keep us in same tax bracket(22%) and big reason for conversion is we won’t need our 401k money based on our lifestyle, and if we don’t go Roth we will have to start distribution at 70.5 age even though we won’t need it and i am trying to avoid that. and the reson for 72T rule use is not only i can convert to roth now, but also i can use some of the conversion $ to pay towards the tax that i will have to pay for roth conversion. so please help.If you have any other strategy I should use to achive my goal of roth conversion and use some of the conversion $ to pay tax in 2021 please share.thank you.   JK

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