IRA recharacterization problem....

[Guest OZZY]

I converted to a Roth IRA in 1998. During the year I made a distribution thinking it was required (I am older than 70 1/2). After receiving my 1099R from the conversion I realized it was not in my best interest to convert to Roth IRA. In Feb 1999 I reconverted back to a Traditional IRA. My question is do I have to pay the 10% penalty on the distribution I made while it was in the Roth IRA ? Please Help me! Thanks!

[Kathy]

If you are talking about the 10% premature distribution penalty, no you don't owe it because you are over 59 1/2. That penalty only applies to people who are under 59 1/2 and don't meet one of the exceptions (disability, first-time home purchase, etc...)

[Guest OZZY]

Hey Kathy does this also apply to distributions out of a ROTH IRA, because that is where I took the funds out, when my money was in the ROTH IRA account. I thought there was a penalty for early withdrawal from a ROTH IRA. Does the fact that I reconverted back to a Traditional IRA relieve me of this penalty or is it because I'm an older gentlemen (over 59 1/2)? Thanks.

[Kathy]

Ok, you're probably going to need to confirm this with your tax advisor but here goes: Since you are into or past your 70 1/2 year, your required minimum distribution was not eligible to be converted to a Roth. So, let's say you had $1,000 in your traditional, you converted the entire amount to a Roth but then realized that your RMD ($100 for purposes of this discussion) was not eligible to go into the Roth as a conversion so you took a distribution of that amount. I would look at it as a correction of a mistake in converting it in the first place, and simply pay taxes on it. Then I am assuming you recharacterized the $900 plus earnings that was left in your Roth IRA back to a traditional IRA. So, I think you are fine there - just pay taxes on the RMD.

But, a more basic concept to understand is that money coming out of a Roth is first treated as a tax-free, penalty-free distribution of your own contributions. Then, once those have been distributed, the next money that comes out is your converted amounts (on which you have already paid taxes). If the conversion occurred fewer than 5 years prior, those amounts would be subject to a 10% premature distribution penalty but only if they would be subject to that penalty if the distribution occurred from your traditional IRA. Since you are over 59 1/2, you would not be subject to a penalty on a distribution from your traditional IRA and therefore will not be subject to a penalty on a distribution of conversion money from the Roth IRA (regardless of the holding period). Finally, once you have received back all of your own contributions and converted amounts, the earnings are distributed. Those will be subject to income tax if you have not had a Roth IRA for at least 5 tax years but, since you are over 59 1/2, they will not be subject to a 10% premature distribution penalty.

Hope that helps and doesn't muddy the water.

[Guest OZZY]

THANKS KATHY IT IS MUCH MORE CLEAR. ONE MORE THING. SINCE I MADE THE RECHARACTERIZATION IN FEB OF 1999 DO I GET A 1099R FOR THIS AND IF SO FOR WHAT YEAR '98 OR '99. HOW IS THIS REPORTED ON MY 1040 IF I ONLY HAVE THE 1099R FROM THE CONVERSION TO THE ROTH IRA. THANKS AGAIN.

[Kathy]

OZZY, this is where it gets really weird. Since you made the recharacterization in 1999, it will be reported to you on a 1999 Form 1099-R which you should receive early in the year 2000, assuming all of the systems haven't shut down at the stroke of midnight and taken us back to the year 1900. So, you will have to complete your tax return (specifically the Form 8606) without benefit of a Form 1099-R. I believe the form asks for a letter of explanation to be attached.

[Guest dusty88]

I set up a 1997 traditional IRA in March 1998 then rolled it into a Roth before april 15, 1998. I didn't take any deduction, of course. Now my 2K acct. is worth about 500 dollars. Can i reconvert to the original 1997 traditional IRA and then deduct the original 2000 dollars on my 1998 tax return? I would just leave the 500 bucks in the traditional and not go back to a Roth. Thanks, Dusty

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dusty

[Kathy]

Dusty,

I’m not sure I understand all the facts. Is this your only IRA or do you have other accounts other places? Did you make the required written irrevocable election to treat the March 1998 contribution as a 1997 contribution? Did you file a Form 8606 with your 1997 tax return?

Here is my rough (very rough) take on it:

1997 (March 1998) – irrevocable written election to treat contribution as contribution for prior year (1997), not deducted so should have been reported on 1997 form 8606, now have basis in IRA. (Should have been reported as a contribution on form 5498 by trustee meaning IRS expects to see on either 1040 as deduction or form 8606 as non-deductible)

1998 – Convert IRA to Roth IRA – If this is the only IRA you have, basis is converted tax-free, earnings are taxable. If you have other IRAs, a smaller part of the distribution will be tax-free and the rest taxable (but no penalty for amounts converted to Roth). The taxability of the distribution/conversion is determined using form 8606.

Now, if you recharacterize, you will not have a taxable distribution for 1998 at all. But, I don’t see how you can take a deduction 1998 for an IRA contribution for which a written irrevocable election was made to treat it as a 1997 contribution??

I think we need more facts.