Slott Report Mailbag: Roth Conversions and Recharacterizations Leave This Reader Confused

By Joe Cicchinelli, IRA Technical Expert

Follow Me on Twitter: @JoeCiccEdSlott

This week’s Slott Report Mailbag looks at IRA beneficiary language and procedures as well as Roth conversions and recharacterizations, a topic we cover heavily in Ed Slott’s 2014 Retirement Decisions Guide. 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.

Hi Ed,

I need help! My father passed away in February of 2012. He was listed as beneficiary on my sister’s IRA. She passed away May of 2012 and did not change the beneficiary. PNC Bank said there are only two choices. The IRA will become part of her Estate, which can be taken out in a lump sum or the Administrator of her Estate can take MRD (minimum required distribution) and the Estate pays the income taxes, which are around 40%. They said there is no option for me, the only heir, to move it to an inherited IRA where I would pay the income taxes at a much lower rate when the MRDs were taken. Does this sound right? Is it just their policy or is this the law? I understand in this case the IRA is subject to pay debt, but there is none. I don’t understand why I don’t become the beneficiary of the IRA through probate. I hope this makes sense and any knowledge and advice you have on this would be greatly appreciated!

Thank you,
Paula Braham

Answer:
Assuming your sister’s estate is the default beneficiary under PNC’s IRA document, the only way you can become the IRA beneficiary is if the IRA assets are transferred (or assigned) through her estate to an inherited IRA in your name as beneficiary of her. In some cases, the IRS has allowed a beneficiary of an estate to transfer IRA funds to an inherited IRA in the beneficiary’s name, as beneficiary of the deceased IRA owner. However, because the estate was the original beneficiary, you cannot use your single life expectancy (stretch-IRA) and would have to take the money out over 5 years assuming she died before her required beginning date. Unfortunately though, the IRS has approved these transfers only on a case-by-case basis in Private Letter Rulings (PLRs). The IRS fee for a PLR is $10,000, not including professional fees to draft the ruling. You may want to speak with an attorney who is familiar with this area of the law to see if assigning the IRA assets to you is possible.

2.

Hello,

Through my employer, I just switched my 401(k) contributions to a Roth, however I have kept the contributions going into the same fund. So, now my 401(k) and Roth 401(k) contributions are mixed. I can track how much of each type I’ve contributed, but when it comes time to do a rollover (or qualified withdrawal), will it become difficult to figure out how much should be rolled into each type of 401(k) (Roth v. Rollover) given the gains (or losses) resulting from each type of contribution?

If so, should I now start directing the Roth 401(k) contributions to a new fund – and move the Roth 401(k) portion of the original fund to the new fund to keep them separate?

Thanks much,
Joe

Answer:
The 401(k) plan should be tracking the Roth 401(k) funds and their attributable earnings separately, despite the fact that they are invested in the same fund.

3.

I am confused by the rules around the Roth conversion and recharacterization process.

If I want to undo a conversion, I recharacterize the assets back to the traditional IRA…I got that; but to convert those assets again (now at a lower basis), do I have to wait until the next January or can I simply open a new Roth conversion IRA (with a new account number) to convert the assets?

If the new account is needed, can I then use the old account once January comes for the next year’s conversion without any problems?

Your articles are so helpful…thank you very much!

Kris

Answer:
Once you convert and then recharacterize, you cannot reconvert those same funds until the year after the year of the conversion or more than 30 days after the recharacterization, whichever is later. For example: if you converted up to November 30, 2013 and recharacterized in 2014, you have to wait more than 30 days before you reconvert. That is a shorter time period than waiting until the next year (2015). If you converted in March 2013 and recharacterized in November 2013, you can now reconvert because it is now the year after the conversion. The simplest way to think about it is – you can only convert those assets once in a calendar year. You do not need a new Roth IRA for the reconversion. But, if you think you might want to recharacterize again, it is easier if you keep the assets in a separate Roth IRA until the recharacterization time period has lapsed.