With all the confusion going on about RMDs and the pandemic, I made a Roth conversion in March from a traditional IRA. I had not taken my RMD yet, and I am planning to take it in a few days before the end of the year (2022). I just learned that you can't do a Roth conversion before taking the RMD and this can result in a 50% Tax? However, I believe I can apply for a waiver, but I have to pay the taxes first.
My first instinct is take the RMD out, as planned, before the end of the year and then figure out the taxes and apply for a waiver next year when I file 2022 taxes. I will make the RMD in good faith before the end of the year to correct the timing issue. Also the value of the conversion has declined since march, and I will be paying taxes on the higher amount.
Is there a better way to handle this since I have a couple of weeks before the year end?
Much Thanks!
It is not a problem if your IRA still has enough value to allow you to take out the RMD.
The deadline for RMD is 12/31.
In which case there is nothing special happening on your 2022 tax return.
it doesn't sound like that at all. Reread the original post.
No I didn't convert the entire IRA. The issue is timing. You are supposed to take the RMD before making any Roth Conversions. I didn't realize this. I am taking the RMD AFTER the ROth Conversion done in March (at Vanguard). In order to avoid IRS issues, is there a better way to handle this before year end other than take the RMD and figure out how to deal with it at tax time?
Assuming a partial conversion:
All your IRA distributions will be reported on your 1099-R. The portion that satisfies the RMD is not eligible to be converted, but the tax form won't know what order the distributions occurred. Suppose you withdraw $5000 and convert $20,000, and your RMD is $4000. Your 1099-R will report a $25,000 withdrawal. The first $4,000 is considered as applying to the RMD, leaving $21,000 eligible for the conversion.
So I don't think you have an actual problem, as long as the converted amount is equal or less than the amount eligible to be converted. You might have a problem if the RMD is supposed to be calculated on the pre-conversion balance instead of the post-conversion balance, so just withdraw enough extra so that can happen. As long as you complete the withdrawal before 12/31 (which means starting the withdrawal before Christmas to give the banks time to process the request) then I think you are fine.
Where the big problem occurs is if you convert the entire IRA balance to a Roth IRA. In this case, you fix the problem by contacting the Roth custodian and requesting the removal of excess contributions. Suppose you converted the entire balance of $100,000 but you were supposed to take an RMD of $4,000. You will withdraw $4000 from the Roth as an "excess contribution" (this is a special procedure, not a regular withdrawal). Then on your tax form, you would report a $100,000 distribution from the IRA, and a $4,000 RMD, leaving $96,000 eligible for conversion. As long as the conversion amount reported by the Roth custodian is less than $96,000 (because you withdrew the excess amount), you are in the clear.
I will correct this if @dmertz has a better answer, but I believe this is what you need to do.
@Jack-A-Lope wrote:
No I didn't convert the entire IRA. The issue is timing. You are supposed to take the RMD before making any Roth Conversions. I didn't realize this. I am taking the RMD AFTER the ROth Conversion done in March (at Vanguard). In order to avoid IRS issues, is there a better way to handle this before year end other than take the RMD and figure out how to deal with it at tax time?
I don't think it's actually a problem, see my other comments. I think the sites that tell you to take the RMD before doing a conversion are assuming you are doing a full conversion.
I take back my original answer.
The problem is that there is a problem because the converted amount is a distribution and that is considered RMD until the RMD is satisfied, and you can't put RMD into a Roth. Catch-22.
You can report your error but you do not have to pay any penalty up front.
you treat the converted amount as Roth contribution. If it is an excess, you can resolve it next year by using your allowed IRA contribution as an offset.
This is really arcane and as I said before in other threads, who's going to know this?
Thanks for the quick responses. As noted, some of the online resources on this are confusing.
Here are real numbers, rounded. I made a Roth conversion in March of $60,000. I need to make a $50,000 RMD for 2022. There is plenty left in the IRA. So if I understand what you are saying, here is the best / easiest way to handle this:
Take the RMD before year end. When filing taxes, the 1099-R forms don't make a distinction about timing as long as the RMD is fully taken out, and of course, not converted. When filing taxes don't do any special treatment and everything should be fine.
@fanfare wrote:
I take back my original answer.
The problem is that there is a problem because the converted amount is a distribution and that is considered RMD until the RMD is satisfied, and you can't put RMD into a Roth. Catch-22.
You can report your error but you do not have to pay any penalty up front.
you treat the converted amount as Roth contribution. If it is an excess, you can resolve it next year by using your allowed IRA contribution as an offset.
This is really arcane and as I said before in other threads, who's going to know this?
[note added: per @dmertz below, this is not technically correct, but the paperwork will look correct and might not raise any red flags.]
As I mentioned, any withdrawal must first go to the RMD. However, there is only one 1099-R form and the transactions are not reported by date. If the taxpayer in my example converted $20,000 in April and withdrew $5000 in December, the 1099-R will show a $25,000 distribution. If the RMD is $4000, then Turbotax will determine that $21,000 was eligible for conversion. (You check the box that "part of the withdrawal is an RMD", Turbotax will do the calculation and determine how much of the withdrawal is eligible for conversion.). As long as the conversion was less than the eligible amount, it won't show up as an error.
@Jack-A-Lope wrote:
Thanks for the quick responses. As noted, some of the online resources on this are confusing.
Here are real numbers, rounded. I made a Roth conversion in March of $60,000. I need to make a $50,000 RMD for 2022. There is plenty left in the IRA. So if I understand what you are saying, here is the best / easiest way to handle this:
Take the RMD before year end. When filing taxes, the 1099-R forms don't make a distinction about timing as long as the RMD is fully taken out, and of course, not converted. When filing taxes don't do any special treatment and everything should be fine.
[note added: per @dmertz below, this is not technically correct, but the paperwork will look correct and might not raise any red flags.]
This is what I believe to be correct. Your tax return must show that you withdrew at least $110,000. $50,000 is deemed to satisfy the RMD, leaving $60,000 eligible for conversion. I don't think it matters that you got the order wrong (and the form won't even show it) as long as the math is correct.
Since the conversion is considered RMD, you already took some or maybe all of your RMD.
Your "reasonable cause" explanation attached to Form 5329 will tell the IRS what you did and how you are correcting it.
Because of the first-out rule for RMDs, the distribution that you made from the traditional when you did the Roth conversion included your RMD, or at least part of it, and depositing that portion into the Roth IRA was not permitted and that portion is a failed conversion. It therefore constitutes a regular contribution to the Roth IRA, not a conversion contribution, and is an excess contribution to the extent that it exceeds what you are eligible to contribute to a Roth IRA as a regular contribution.
Assuming that you cannot treat it (or a portion of it) as a regular contribution, or you do not want to do so, the proper remedy is to obtain an explicit return of contribution from the Roth IRA. The distribution must be accompanied by any attributable investment gain or loss. Any investment gain will be taxable as ordinary income on your 2022 tax return. Whether you treat the failed conversion as a permissible regular contribution or as an excess contribution, you need to inform the Roth IRA custodian so that they treat the amount of the failed conversion as a regular contribution.
The non-legal alternative is to ignore the issue and just take another distribution from the traditional IRA equal to the amount of your RMD for 2022. Because the IRS doesn't receive information regarding the dates of the transactions, the IRS is unlikely to detect the failed Roth conversion. If they ever do, though, you'll likely have an excess contribution penalty for each year the failed conversion remained in the account and was not able to be applies as a regular Roth IRA contribution.
Sometimes your Roth IRA grows so fast that the 6% excess contribution penalty can be easily absorbed.
But it appears that those days may be over.
@dmertz , thanks.
So this is what you would do if you want to be in exact compliance.
"I made a Roth conversion in March of $60,000. I need to make a $50,000 RMD for 2022. There is plenty left in the IRA. So if I understand what you are saying, here is the best / easiest way to handle this:"
Step 1. Contact the Roth trustee and tell them that $50,000 of the conversion was an "excess contribution" and you need to withdraw it. The plan knows what to do for excess contributions and they will return the money with any gains or losses, and you will report the gains as taxable income.
Optional step 1a. If you have compensation from working this year, you can contribute up to $7000 (since you are over age 72) to the Roth IRA as a regular contribution. If you have not made your contribution yet, you could tell the custodian, "$50,000 is excess, but treat $7000 as my contribution and return $43,000 to me." Or you could take the whole $50,000 as a return of excess and then send your contribution separately (if you are eligible).
Optional step 2. After you have satisfied the "first-out" rule (by taking a return of excess contribution, so that $50,000 from the March withdrawal is used to satisfy your RMD), you would then be eligible to make a new Roth conversion from the IRA in any amount, as long as you get both transactions processed by 12/31. If you converted another $50,000, you would end up more or less where you would be anyway, except the date of the Roth Conversion would be December instead of March.
@fanfare wrote:
Sometimes your Roth IRA grows so fast that the 6% excess contribution penalty can be easily absorbed.
But it appears that those days may be over.
The penalty for missing the RMD is 50% of the missed RMD. That's on top of the 6% penalty for excess contributions, which the taxpayer has to pay every year until the excess contribution is removed.
@Opus 17, @dmertz -- Thanks so much for the responses.
The Roth conversion was done in March, and there would definitely be a loss if the excess contribution was returned, so there won't be any additional tax involved, correct?
Optional Step 1a is irrelevant to me (no more work), but thanks for laying it out.
Optional Step 2 is what I would do, if I do it. All the money is with Vanguard
If I understand it, doing the excess contribution step is fairly easy. I would then do a new rollover with the $50,000 and I would basically be in the same place tax wise, except now I have the RMD and Roth conversion in the correct calendar order. I don't think this will have much of a financial impact, correct? If I do this, will I have to fill out form 5329?
One concern is if Vanguard will process this correctly and the correct 1099-R form will be generated. From this conversation, it sounds like the 1099-R form would be almost the some if I didn't do this, correct?
Regardless, whether I did or didn't process the excess contribution, I am making a good faith effort to correct it which seems to be the standard for any waiver of excess tax on form 5329.
"The Roth conversion was done in March, and there would definitely be a loss if the excess contribution was returned, so there won't be any additional tax involved, correct?"
Correct. Be aware that the gain or loss is calculated with respect to the entire Roth IRA account.
"If I understand it, doing the excess contribution step is fairly easy. I would then do a new rollover with the $50,000 and I would basically be in the same place tax wise, except now I have the RMD and Roth conversion in the correct calendar order. I don't think this will have much of a financial impact, correct? If I do this, will I have to fill out form 5329?"
Correct, no real financial impact. With the corrective distribution made from the Roth IRA, there is nothing to report on Form 5329. If the amount originally moved to the Roth IRA as an intended Roth conversion was more than your RMD, the RMD has been satisfied. The only reason you would have Form 5329 with regard to all of this is if by the due date of your 2022 tax return, including extensions, you fail to correct the amount now in the Roth IRA which must be reported as an excess contribution. If corrected, you won't have an excess contribution to report on Form 5329.
"One concern is if Vanguard will process this correctly and the correct 1099-R form will be generated. From this conversation, it sounds like the 1099-R form would be almost the some if I didn't do this, correct?"
The code-7 Form 1099-R will total the distributions from the traditional IRA. There is nothing special about that. The return of contribution must be requested as such, not a regular distribution, so that the Form 1099-R reporting this corrective distribution will have codes J and 8 if done in 2022 or codes J and P if done in 2023 before the due date of your 2022 tax return, including extensions.
this is from the following webpage
The distribution is deemed to satisfy the RMD, so your RMD has been completed. However, the RMD amount was not eligible for rollover and became an excess regular Roth contribution. Explain to the Roth custodian what happened and request a return of the excess amount with allocated earnings. The earnings will be taxable, but will be small so this is not costly. However, it is messy to report on your tax return because what you report will vary from the 1099R for the conversion. You will only report the allowable amount of the conversion on Form 8606, so the total taxable amount will be your allowed conversion amount (the excess converted over the RMD) plus the excess contribution amount (really the RMD) plus the earnings on the excess amount returned to you.
You can satisfy your total RMD from just one account, but you must complete that before converting any additional amounts. In other words, the total RMD must be withdrawn from any account you wish, and afterwards you can convert more from any account you wish.