ROTH CONVERSION OF ANNUITY MAY HOLD A SURPRISE

Any IRA or employer plan can now be converted to a Roth IRA. But for owners of retirement assets that are invested in an annuity, there could be a little surprise come tax time.

Many individuals invest their tax-deferred retirement assets in a tax-deferred annuity. This seems counter-intuitive so why would anyone do this? Many times the answer is for the guarantees that are in the annuity. For example, you can have a guaranteed living benefit or a guaranteed death benefit. With recent drops in the market, sometimes these guaranteed benefits are worth more than the annuity itself.

So, what happens if you convert this annuity to a Roth IRA? Many individuals, and many advisors, assume the value of the annuity for conversion purposes is its surrender or cash value only, but they would be wrong. At the time of the conversion, the value of the annuity will include a current value for any guaranteed benefits in the annuity. You can only find out this number from the insurance company holding the annuity. The company will report this value to IRS, and to the individual, on the Form 1099-R that they issue. This is the amount that will have to be included in income, not the cash surrender value, when the individual files their tax return for the year of conversion.

That's the bad news. The good news is, if you get a surprise like this, you can recharacterize the conversion up to October 15th of the year after the conversion.

Private Letter Ruling 201003032:

"Paula" received a distribution from an IRA maintained by her financial institution. She intended to roll over this distribution to another IRA to be established at her bank.

However, "Paula" asserted that her failure to accomplish the rollover within the prescribed 60-day window was due to the Bank's error. This situation has another twist because 'Paula' moved to the U.S. as an adult and has limited understanding of the English language, hindering her from noticing the Bank error until the 60-day period had passed.

Earlier, she had been persuaded to move her IRA investments from Certificates of Deposit to an IRA annuity to obtain a better rate of return. She received bank statements from the financial institution. "Paula" contended that although statements showed monthly withdrawals were made from the IRA, she received just one check per year at the end of the calendar year without making a request.

Eventually, she received a check from the financial institution for what we will call Amount G, which was Amount F minus required withholding. Amount F was a distribution of the total surrender value of the IRA. "Paula" went to the Bank and presented the check for Amount F and proceeds from a non-IRA Certificate of Deposit that matured. She says she told the teller that the check was IRA money. However, the Bank established an account -- a non-IRA Certificate of Deposit -- for the benefit of Paula in which both the distribution from the IRA and proceeds of the matured non-IRA Certificate of Deposit were deposited.

When "Paula's" son-in-law went through her tax return a year later, he realized "Paula" had received a total distribution from the IRA instead of only the required minimum distribution. At that time, more than 60 days after Paula received the check, she became aware that the Certificate of Deposit had been established as a non-IRA Certificate of Deposit.

"Paula" wanted IRS to waive the 60-day rule; however it declined her request for an extension because 'Paula' had not submitted sufficient documentation to prove she gave the Bank teller correct information in regards to her IRA money and non-IRA CD proceeds. Therefore, IRA proceeds and non-IRA funds were placed in the same non-IRA account rather than two separate accounts..