RMDs Under the Secure Act & Roth Conversions: Today's Slott Report Mailbag
By Sarah Brenner, JD
Director of Retirement Education
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Would you kindly clarify the rule that governs the withdrawal period and the tax implication (if any) of RMDs from an inherited IRA? The SECURE Act and the IRS document 590B are not clear.
Here is the situation: I have a traditional IRA with my granddaughter as the sole beneficiary. My understanding is that before the SECURE Act, inherited IRA's had to issue annual RMD's if the original owner was taking them. The SECURE Act seems to say that annual RMD's are no longer required to be taken by a non-spouse beneficiary, just as long as the account is fully distributed in the 10-year period.
Am I correct is assuming that all inherited IRA RMD funds, however distributed in the 10 years, will be taxable to my granddaughter?
Interesting question! The SECURE Act was a game changer for inherited IRAs. You are correct that before the SECURE Act IRA beneficiaries such as your granddaughter could stretch RMDs over their life expectancy. That meant that annual RMDs needed to be taken. With the SECURE Act, most beneficiaries will no longer have the ability to stretch RMDs over life expectancy. Instead, most will be subject to a 10-year payout period. Unless there is basis in the traditional IRA, any distributions taken by your granddaughter during this period will be taxable to her. There is some good news, however, about the 10-year payout period. There are no annual RMDs. This allows some flexibility for beneficiaries. They can take more or less each year depending on their tax situation. It is even possible to skip years. However, the entire account must be emptied by December 31 of the tenth year following the year of death.
A client transacted a “reverse rollover” from their traditional IRA in 2020 into their corporate 401(k) plan. After doing so, but in the same year, they made a non-deductible IRA contribution, then transacted a Roth conversion with these monies. Does this Roth conversion fall under the pro rata rules due to it being done in the same year, but after the reverse rollover was completed?
Thanks for your help!
Whenever a conversion from a traditional IRA to a Roth is done, the pro rata rule applies. That means that we have to consider all of an individual’s IRA funds when determining the taxation of a conversion. This rule trips up many IRA owners looking to take advantage of the backdoor Roth strategy where they make nondeductible traditional IRA contributions and then convert them. If they have other IRA funds, they may be looking at an unexpected tax bill.
However, in your situation, the client has found a way to avoid this pitfall. By moving taxable IRA funds to the 401(k) plan by December 31, 2020, they will avoid having those funds being included in the pro rata formula to determine the taxation of the 2020 backdoor Roth conversion. It does not matter what order in which the reverse rollover and the conversion happen. A long as the reverse rollover is done by December 31, 2020, those funds will not be included in the pro rata calculation.
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