Dear Mr. Slott,
I have been receiving your e-mails for a number of years and have read your comments in The Wall Street Journal long before that - and have always found them of value. I have two questions I am hoping you can help me with that I believe have not been asked and/or addressed yet.
I am in the "sweet spot" as you call it. I have a large Traditional IRA at a bank and wish to convert some of it, but not all of it, to a Roth and pay the tax on the amount I convert. I figure with the tax law changes and the fact my income is very low, right now it is a good time to do so. Am I able to make that kind of partial conversion or do I have to convert the entire balance in the Traditional IRA?
My second question is based on the first. If I can make a partial conversion this year, am I able to make another partial conversion next year, the year I turn 70 1/2, the same year I will take my first RMD? If so must I take the RMD first and then convert or can I convert first but make sure I take the RMD later in the year based on the previous year's balances at year-end?
Thank you for your help,
Making a Roth IRA conversion when you are in a low-tax bracket year is a good idea.
Yes, you can make a partial conversion of a traditional IRA to a Roth IRA. In fact, making a series of partial conversions is a way to minimize the tax cost of a conversion. By spreading the income realized from a conversion over several years, one may be able to keep it from piling up into higher tax brackets.
And, yes, you can make a partial conversion in the year you reach age 70½. If you do, be sure to take your RMD before you make the conversion. When an RMD is required for a year, the IRS considers the first funds taken out of an IRA to be the RMD. Those RMD funds are ineligible to be moved directly into another IRA or to a Roth IRA. If they are, they will be considered an excess contribution subject to a 6% penalty. The penalty will repeat every year until the funds are withdrawn.
After you take your RMD you can convert as much of your IRA to a Roth IRA as you wish. Moreover, after RMD funds are deposited into your checking account, you can even use them to fund a contribution to a Roth IRA, provided you are eligible to do so under normal rules (e.g.: you have earned income and are within the income limit for eligibility) or you can use them to pay the tax on the Roth conversion.
My situation is that I have elderly parents (ages 80 and 84) who never took their required distribution from a traditional IRA. My father had this IRA since 2009. He is 84 now but it appears he did not get this IRA until he was about 70.
He now has beginning dementia and does not remember if anyone contacted him about his distribution. Unfortunately, my parents aren't financially literate and are afraid of what may happen. According to my mother, the IRA is only about $13,000.
I live far away and I am trying to help. I called the IRS on their behalf and was told no one has reported (not even the custodian) this missed distribution.
An IRA owner must take required minimum distributions (RMDs) starting at age 70½. Starting that year, the custodian of the IRA is required to inform the owner every year that an RMD is due.
The rules are different for beneficiaries of IRAs, who have inherited IRAs. Regardless of age, they must begin taking annual RMDs in the year after that in which the IRA's owner died. And the custodian of an inherited IRA is not required to inform the beneficiary that an RMD is due for the year.
The penalty for failing to take an RMD is steep - 50% of its amount. However, relief from the penalty can be requested by taking the overdue RMDs and filing IRS Form 5329, giving an explanation for the failure. The IRS is reasonable about granting relief when taxpayers have acted in good faith.
It seems in your case that your father may have inherited the IRA as a beneficiary and never received any notice that the RMDs were due. If he was also financially unsophisticated when he inherited the IRA, and is now ill, these are factors to mention on Form 5329 when requesting penalty relief.
In any event, you should learn all the facts about the IRA, including when your father inherited it (or established it), its annual account balances, and a list of all the RMDs he should have taken. You will need this information for Form 5329. Obtain it by contacting the IRA's custodian.