Roth Conversion mistakenly registered as Traditional IRA Rollover
I elected not to take my 2020 RMD as allowed in COVID legislation. So it was a good time, tax-wise, to make my first Roth conversion. Had it been done correctly, I would have gone from a TIAA-CREF trad earning 3.6% to a Roth earning 3.2% in an insurance company fixed 5 year annuity. My financial services firm was to have handled the details for me, and did so in July, 2020. Now I have received a 1099-R from TIAA_CREF showing a non-taxable rollover (Box G). I called the financial services firm and they openly admitted, oops, we didn’t set your IRA with the insurance company up as a Roth, but mistakenly as a traditional rollover from one institution to another. They also tell me that there is no way to fix it, except to recharacterize the new IRA, but that will happen at the current interest rate of 2.4% or so. Did they try hard enough to find a corrective solution? Isn’t there some way to fix a clerical error that will not cost me so much in interest? I wish I had left well enough alone!! Al advice welcome, thanks in advance.
Permalink Submitted by Alan - IRA critic on Fri, 2021-02-05 15:32
I’d be more concerned that they botched a rare chance to do the conversion in a lower tax bracket than the interest rate difference. What happens is that you did save on your 2020 tax bill, but at the cost of higher RMDs and higher taxable income in the future plus the lower rate.
This was not an IRA custodian error, it was apparently an advisor error. Advisors who direct alot of business to insurance companies may have some pull for accomodations from the carrier. If not, they should have some form of E&O insurance that they could file a claim with. The problem here is that any solution involves both the advisors and the insurance company, and that makes it more challenging to resolve than if you were dealing directly with the insurance company and the insurer made the error.
It’s not clear exactly what they meant by “recharacterizing the IRA”. If they mean that they will establish a Roth IRA for your retroactively to 2020 and request a corrected 1099R from TIIA, that would be better. Or perhaps they might offer the 3.2% rate without changing the IRA to a Roth. Either would fall short of what you really should have, the Roth IRA at the 3.2% rate. You may wish to retain an attorney to send them a letter, but it would have been far better to have done this last year since the passage of time makes this error more difficult to correct.
Permalink Submitted by brian shanley on Sat, 2021-02-13 14:02
Thank you Alan. I wrote a respectful note to the owner of the financial services company. He tried to exercise some clout with the insurance company but that did not work. So he consulted with a tax attorney. The outcome is as follows: The tax attorney knew what to do. The financial services firm will pay for him to do my taxes. I’ll pay Roth IRA conversion taxes now and file a magic form with the IRS. In 5 years when the annuity is over, we’ll file another magic form and the Roth conversion will be complete. I hope it works! And I think the financial services firm treated me right.
Permalink Submitted by brian shanley on Sat, 2021-02-13 15:02
Thank you Alan. I wrote a respectful note to the owner of the financial services company. He tried to exercise some clout with the insurance company but that did not work. So he consulted with a tax attorney. The outcome is as follows: The tax attorney knew what to do. The financial services firm will pay for him to do my taxes. I’ll pay Roth IRA conversion taxes now and file a magic form with the IRS. In 5 years when the annuity is over, we’ll file another magic form and the Roth conversion will be complete. I hope it works! And I think the financial services firm treated me right.
Permalink Submitted by Alan - IRA critic on Sat, 2021-02-13 15:30
It is not clear what they plan to do, other than to have you pay the conversion taxes and report a conversion to the IRS on your return with an explanation. The IRS may or may not accept accept this, but if the new insurance company maintains your IRA as a traditional IRA, the IRS will expect that RMDs be distributed, either from that IRA or another IRA you may have based on the combined year end balances. SInce you are subject to RMDs this will create a problem every year not only with the IRS thinking your RMD was short, but the conflict of reporting a distribution from the annuity that the insurance company will report as a TIRA distribution, while your 1040 forms are treating this as a Roth. The only good solution probably will require the IRS to send a notice to the insurance company to retroactively title the account as a Roth annuity. That would solve the issue for good, otherwise there will be issues every year and at the end of the 5 years. You will get a copy of your returns, so you can see what was reported, and should also get a copy of any additional correpondence sent to the IRS on your behalf. It also may take several months to get a response from the IRS since they are way behind due to Covid.
Permalink Submitted by brian shanley on Mon, 2021-02-15 19:19
Thanks. I’ll post again when I find out the details regarding what I casually called the tax attorney’s magic form. I am worried too about the expectations for the RMD in the five year interim. In Saturday’s mail I received a form from the insurance company to set up my RMD distributions. I can see problems.
Permalink Submitted by brian shanley on Sat, 2021-02-27 17:37
The Tax Attorney prepared my taxes for me and explained exactly how he was going to handle the botched conversion. It involved an annual letter of explanation to the IRS explaining what had happened and why the taxes were paid in advance. He was quite confident it would work. But then he asked me if I were nuts for wanting to make the conversion at all. It turned out that my 2020 income significantly surpassed what I expected it to be at the time we made the Roth conversion calculation. So more income was taxable, and more Social Security income became taxable as a result. Instead of a Roth conversion at 12%, I was looking at 20%. Not good. So I left the failed Roth conversion as a trad IRA rollover from one account to another. Of course in doing so I went from 3.6% to 3.2%. That difference is on me and is the price of the lesson learned.
Permalink Submitted by Alan - IRA critic on Sat, 2021-02-27 18:39
Thanks for the update. With any Roth conversion, you find out very soon what tax rate you pay for the conversion, but it takes decades to determine if the conversion was actually beneficial or not. In your case, paying an effective rate of 20% due to inclusion of SS in your AGI, the conversion is less likely to be beneficial in the long run, and even if it would have been, perhaps not by much. You probably made the best decision to let this error remain uncorrected, even though your RMDs are going to be slightly higher going forward.