Consequences of Not Doing Your RMD Before Your RIC
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The lesson of last week’s blog post is that if you’re 70-1/2+, IRS deems the first distributions from your traditional IRA to satisfy your required minimum distribution(“RMD”) and therefore you must always take your RMD before doing a Roth IRA conversion. What are the consequences of not taking your RMD before doing your Roth IRA conversion? This post will answer this question and will discuss how to correct this situation.
At first blush, there would appear to be two potentially serious repercussions:
- 50% penalty on the amount that should have been withdrawn but was not, and
- 6% excise penalty for every year the money remains in your Roth IRA
Answer 6(c) of IRS Regulation 1.408A-4 (Converting amounts to Roth IRAs) enables you to potentially avoid both penalties by treating this situation as two distinct and separate events:
- A required minimum distribution, and
- Regular contribution to a Roth IRA vs. a Roth IRA conversion
If you do a Roth IRA conversion without first taking your RMD, IRS deems the portion of the conversion amount that is equal to your RMD amount to satisfy the RMD rules for that year and thus avoid a potential 50% penalty. This assumes that the conversion amount is at least equal to the amount of your RMD. The portion of your conversion amount that is less than your RMD would still be subject to the 50% penalty.
Assuming that your conversion amount is equal to or greater than your RMD amount, you’re out of the woods as far as your potential exposure to the 50% penalty. What about the 6% excise penalty? There are different rules for eligibility for a regular contribution to a Roth IRA vs. a Roth IRA conversion. Since your RMD amount is now treated as a regular contribution to a Roth IRA, your avoidance of the 6% excise penalty depends upon whether or not you are eligible to make a regular contribution to a Roth IRA as well as your RMD amount.
Eligibility for regular contributions to Roth IRA’s is dependent upon having earned income equal to at least the amount of the contribution and is also dependent upon the amount of one’s modified adjusted gross income (“MAGI”) which differs by filing status, the details of which are beyond the scope of this blog post. Even if you meet the eligibility requirements, the maximum amount of your Roth IRA contribution is limited to $6,000 if you’re age 50 or older.
If you don’t meet the eligibility rules for making a regular contribution to a Roth IRA, the portion of your Roth IRA conversion that is deemed to be an RMD will be subject to the 6% excise penalty. Furthermore, even if you satisfy the Roth IRA regular contribution rules, to the extent that the RMD portion of your Roth IRA conversion exceeds $6,000, it will be subject to the 6% excise penalty until it is corrected.
If you are either ineligible to make a regular contribution to a Roth IRA or, if you are eligible and the RMD portion of your Roth IRA conversion exceeds $6,000, how do you correct this situation and avoid the 6% excise penalty? In order to avoid the penalty, you must transfer the portion of the conversion that is deemed to be an RMD that doesn’t meet the Roth IRA regular contribution eligibility requirements plus earnings thereon back to your traditional IRA by the due date, including extension, for filing your tax return for the year of conversion.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.
