Ask Ed Slott: Avoid This Costly Conversion Mistake
If one is currently taking his scheduled RMD, and decides to convert his IRA to a Roth IRA, must he still take the scheduled RMD before the conversion? If the individual has already converted his IRA to the Roth IRA without first taking the RMD, can he transfer the RMD amount back to his IRA and then make the appropriate RMD distribution from his reconstituted IRA?
Yes, you must take your RMD before the conversion to a Roth IRA. If you erroneously converted your RMD to a Roth IRA, that amount is treated as a regular Roth IRA contribution, which may create an excess Roth IRA contribution. An excess contribution is subject to penalties unless timely corrected.
You must tell the Roth IRA custodian that you are taking a distribution of an excess contribution. Either the custodian or you will have to do a net income calculation on the amount of the excess contribution. The net amount is then distributed from the Roth account.
This is the only way to fix the problem of mistakenly converting your RMD amount to a Roth IRA. You have until October 15 of the year after the excess contribution to correct it. If it is not timely corrected, the excess amount is subject to a penalty of 6% per year for each year that it remains in the Roth IRA.
Per IRS publication 590, am I able to transfer my annual RMD from my traditional IRA to open a Roth IRA?
No. RMDs are not eligible to be converted to a Roth IRA or to be rolled over to another retirement plan. However, if you are eligible to make a Roth IRA contribution, you can use funds from your IRA distribution to make a Roth IRA contribution.
My traditional IRA account consists of mutual funds and a money market account. I would like to convert the entire portfolio to a Roth IRA account and then do a partial recharacterization if the conversion bumps me into the next tax bracket. Can I recharacterize just the dollar amount I need to avoid the bump? How do I account for earnings on the converted funds?
A recharacterization is always done by a dollar amount, plus or minus the attributable gains or losses, of any amount you decide to recharacterize. A recharacterization is nontaxable. The funds are treated as though they never left the traditional IRA and the attributable gains or losses occurred in the traditional IRA.