The IRS hasn't provided answers for all the Roth conversion questions out there, leaving some taxpayers in the lurch.
Top estate planning and investment professionals rely on Natalie Choate's best-selling book Life and Death Planning for Retirement Benefits, often called the "bible" of retirement benefit distribution planning, for everything they need to know about the rules governing their clients' retirement plans and IRAs. Order Natalie's book for $89.95 plus shipping by calling 800-247-6553, or online at www.ataxplan.com.
Question: "Agnes" is 56 years old. She has a $600,000 IRA from which she is receiving a penalty-free "series of substantially equal periodic payments" (SOSEPP). She would like to convert $100,000 of the account to a Roth IRA in 2010. She knows that any "modification" of her SOSEPP prior to reaching age 59½ (or prior to the fifth anniversary of the first series payment, whichever is later) would result in losing her exemption from the 10 percent penalty that is normally applicable to "early distributions." Furthermore, the loss of the exemption would be retroactive so she would owe the penalty on all distributions she has already received under the SOSEPP; since she is already six years into the series, she does not want to risk that happening.
Can she do a partial Roth conversion of the SOSEPP-supporting IRA without causing a modification of the SOSEPP? If the answer is yes, would she continue to take the post-conversion SOSEPP distributions from the money left in the traditional IRA (about $500,000), the new Roth IRA ($100,000), or proportionately from each?
Natalie: I wish I knew.
Under the IRS's Roth IRA conversion regulation, the conversion of a SOSEPP-supporting traditional IRA to a Roth IRA is not treated as a modification of the SOSEPP, provided that the participant continues to take the SOSEPP payments from the Roth IRA following the conversion. That's the good news. The bad news is that the regulation doesn't discuss partial Roth conversions.
If a total Roth conversion is not considered a modification, then there does not appear to be any way the IRS could claim that a partial conversion IS a modification. The IRS guidelines on SOSEPPs state that "nontaxable" transfers from the SOSEPP-supporting IRA to another account are considered modifications; a full or partial Roth conversion is not covered by that prohibition because it is a taxable transfer. But following a partial conversion, we have no guidance on whether the IRS cares about which account the post-conversion SOSEPP payments come out of.
I don't see how the IRS could fault Agnes if, following a partial Roth conversion, she took her post-conversion SOSEPP payments from both accounts, in proportion to the relative sizes of the accounts. I also don't see why the IRS would care if she decided to take all of the post-conversion payments from the remaining traditional IRA money or all from the new Roth IRA. Maybe the IRS would get upset if she fine tuned her SOSEPP payments each year, taking them from both the traditional and Roth IRAs in proportions selected by her to minimize her present and future taxes. But my speculation is worthless; what you need is IRS guidance to be sure of avoiding a modification of the SOSEPP.
It appears to me that Agnes has the following choices with respect to her SOSEPP-supporting IRA, if she wants to avoid risking a modification of her SOSEPP:
1. Do no Roth conversion in 2010. That is the safest course, obviously.