Penalty for Roth Conversion before doing RMD
I understand there is a rule that you are required to do your RMD before doing a ROTH Conversion in a given year. I think there is a 6% penalty for doing the ROTH conversion first. What I don’t understand is how the 6% is calculated. If the asset appreciates more than 6% between the date I do the conversion and the end of the year, would I be better off doing the conversion first? Thanks for all your help.
Permalink Submitted by Alan - IRA critic on Wed, 2021-10-06 21:02
Converting first results in the conversion distribution counting toward your RMD, but the rollover to a Roth IRA (or any retirement account) of an RMD is not permitted. The amount attributed to the RMD becomes a regular excess Roth IRA contribution, but can be removed like any other excess contribution with allocated earnings. If this excess is corrected by the extended tax due date, the 6% excise tax is avoided. If the excess is not removed by this deadline, the 6% excise tax is due on the amount of the excess contribution. Obviously, many taxpayers create these excess contributions by converting first, but since the IRS does not know whether the RMD or the conversion came first without an audit or request for documentation, most taxpayers escape unscathed. IRA custodians may or may not alert IRA owners of these rules.
If the excise tax becomes due, any gains on the excess contribution can remain in the Roth, as the excise tax and removal of earnings are mutually exclusive. Like any excess contribution, if the gains are large enough there can be savings from paying the excise tax for 1 year, leaving the gains in the Roth and then removing just the excess amount by year end to avoid a second year of 6% excise taxes. There is no statute of limitations for such excise taxes, so is is possible to owe several years of 6% excise taxes plus interest.