Actual income vs. 1998-2001 Roth Conversion Income

[Guest John Blake]

A friend converted two conventional IRA accounts into Roth IRAs in 1998, dividing the taxable 'income' (about $87k) into four parts, about $22k annually, ending in 2001. In '98, this $22k Roth conversion 'income' boosted her reported 'income' from about $12k to about $34k. In '99, from about $17k to $39k reported income. For 2000, a projected $27k

actual income to $49k reported.

This is a annual tripling or doubling of actual income vs. reported income. The Roths are considered long-term investments, and some Roth conversion software (T.Rowe Price's) projected a $35k overall savings.

But few institutions seem to differentiate between reported 1040 income and actual income. For example, her '98 actual income entitled her to certain free medical benefits, while the 1040 reported income then and in subsequent years might change that (untested). As another example, parents might fill out an application for college scholarship/financial aid and find themselves reporting 1040 income that's double their actual income. Bureaucratic forms for reporting income may not make distinctions between phantom Roth-conversion income and actual income. This 1998-2001 four-year Roth 'income' split must apply to many people and many situations.

Has anything been written into tax law or the Roth

legislation to minimize such problems? Thanks. -- John

[Guest pelagic2]

John,

Please let me know if and when you find information on this. My mother, a school teacher lives on a 40,000 a year pension. She transferred 300K from an IRA to a ROTH back in 1998 and is now (as far as the government is concerned) making 110,000 a year.

She can barely afford to pay her taxes this year- Have you had any suggestions?

Andrea

[John G]

I think the above post helps demonstrate why everyone who thinks of about a conversion should do the math very carefully and get the advice of a tax professional. Your mom should have known that a 300K conversion in 1998 would add $75K (1/4th of the total) for the next four years to her income. She could have converted a smaller amount each year over a longer period of time to avoid tax bracket creep, but that water long ago passed over the dam.

Perhaps you should help your mom make the tax payments. She can then pay you back each year she takes some of the tax free income from her Roth. If she dies before the Roth is exhausted, the assets pass (per the beneficiary designations) with potentially favorable tax treatment.

You may also want to consider a home equity loan or home refinance