Roth IRA Rollover Rule, 10% Penalty Exception and Roth IRA Conversion Questions Highlight Mailbag

By Joe Cicchinelli, IRA Technical Expert

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Can you believe summer is almost over?  Yet, The Slott Report Mailbag was full of pertinent IRA and retirement planning questions from consumers who are trying to make the right decisions as the dog days rapidly turn into fall.  This week’s installment includes questions (and our answers) on the 60-day deadline on Roth IRA rollovers, 10% penalty exceptions and Roth IRA conversions. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

I am over 80 years old and have sufficient funds in my Roth IRA to purchase a new residence. If I withdraw a down payment and the purchase fails, may I reinvest the same amount that I withdrew for the down payment back into my Roth IRA?

Thanks,

John Heller

Answer:
Yes, but only if you get the funds back to the Roth IRA by rolling them over within 60 days from the date you receive them. IRS has the ability to extend this 60-day deadline, but they generally will not grant an extension when the funds were used while they were out of the IRA. In order to request an extension, you have to file a private letter ruling request and pay a fee to IRS. In addition, there will be a fee to a professional to prepare the request. There is no guarantee that IRS will grant a request for an extension, and it typically takes six to nine months for a ruling to be issued.

2.

Can a person avoid the 10% withdrawal penalty and filing 72(t) if he or she uses withdrawals to pay for health insurance premiums?

Answer:
There is an exception to the 10% early distribution penalty for withdrawals from an IRA when the account owner is unemployed and pays for health insurance. The full requirements that need to be satisfied to qualify for this exception can be found in IRS Publication 590. It is available on the IRS website, www.irs.gov. On the left hand side of the screen click on “Forms and Publications.”

3.

I have $700,000 in an IRA and have considered converting to a Roth IRA as you have recommended. Taxes will have to be paid from the IRA funds.

Question: Should I convert the entire $700,000 this year or do a conversion of 50% this year and 50% next year? Will the tax consequence be less with a 2-year conversion?

Also my wife has earned income of approximately $145,000 per year.

Thank you,

Ken Jordan

Answer:
The decision to convert has many components to it. One of the first things we recommend is that you do two sample tax returns, one with the conversion and one without. Most individuals have their tax returns on a computer these days, which makes this fairly easy to do. The reason that it is important is that when you add income to your tax return many different parts of the return are affected. You could lose tax deductions, credits or exemptions. You might become subject to the alternative minimum tax. Social Security benefits could become taxable. By splitting the conversion over two years, you could become subject to higher tax rates next year – but you won’t know this until Congress acts on the sunset provisions of the Bush tax cuts.

It generally is not a good idea to pay for the conversion tax with IRA funds. This depletes the amount you will have available to you in retirement. Also, you will owe income tax on the amount you use to pay the tax and a 10% early distribution penalty if you are under the age of 59 ½ because those funds were not converted. If you later want to recharacterize your conversion, the funds used to pay the income tax will be “lost.” You will not be able to recharacterize amounts that are not in the Roth IRA.