Roth 2K

Barry C. Picker, CPA/PFS, CFP

As we start the new millennium (which actually doesn't really start until next year, but hey! A party is a party), and year three in the life of the Roth IRA, let's review where we stand.

"Open" conversions
If you withdrew money (other than a mandatory distribution) from your IRA at the end of 1999, you can redeposit that money directly into a Roth IRA within sixty days of the withdrawal, and have it count as a 1999 Roth conversion, assuming you are eligible. You must be very careful with this on two counts. One, the redeposit MUST be made within 60 days. No extensions, no exceptions. Second, the redeposit MUST be directly into a Roth IRA. It CANNOT go back into a regular IRA and then moved to a Roth. Doing so will cause it to become a 2000 conversion, rather than a 1999 conversion. Be careful, and INSIST that the deposit go directly into a Roth IRA.

Recharacterizing 1998 conversions
The IRS previously extended the deadline to recharacterize 1998 conversions until December 31, 1999. That date has come and gone, and no further extension has been forthcoming. Therefore if you converted in 1998 and now decide that you didn't want to, it's too late and you're stuck with the Roth IRA. If it turns out you were not eligible to do a 1998 conversion, your IRA has been destroyed, unless further relief is forthcoming. An improper conversion results in all the income being taxable in 1998, rather than spread over four years. In addition, if you were under 59½ at the time of the conversion, you get hit for an additional 10% penalty tax. Then, to add insult to injury, you are hit with a 6% excise PER YEAR since you are considered to have made an excess contribution to a Roth IRA. The penalty is imposed annually until the excess contribution is withdrawn. Since it is now 2000, you are already subject to the penalty for TWO years so you owe 12%. Once the money is withdrawn from the Roth, you will not have either tax deferred or tax free income. All you are left with is a regular, ordinary taxable account. There is a procedure where you can request, in an official ruling request from the IRS, additional time to make the recharacterization. The procedure is costly but it may pay if your retirement account is large enough. If you plan on following this route, don't do anything until your request is either granted or denied. No further penalties will accrue until the beginning of 2001.

Electing out of the four year spread for 1998 conversions
If you converted your IRA to a Roth in 1998 and did not elect out of the four year spread when you filed your 1998 income tax return, you are stuck with paying the tax over four years. If it turns out that 1999 was a low income year and you want to include the rest of the conversion income on your 1999 income tax return, you are not permitted to. You also cannot go back to amend your 1998 return to include all of the conversion income on that return. The election had to have been made on the original filed return.

1999 Roth withdrawal of 1998 converted amounts
If you took a withdrawal from your Roth in 1999 that included amounts converted in 1998, you must include that amount in your income for 1999, in addition to the 25% that you have to include due to the four year spread. However the amount included in income, taken together with the amounts already included in 1998, cannot exceed 100% of the taxable value of the conversion. For example, if the taxpayer converted $80K in 1998 (no amount attributable to non deductible contributions) and then withdrew $10K in 1999, the taxpayer would have to report $30K of conversion income in 1999, instead of the $20K that would otherwise have to be included. In addition to including the withdrawal in income, you will owe the 10% early withdrawal penalty unless an exception to the penalty applies. Having attained age 59½ prior to the withdrawal IS an exception.

Death in 1999 of taxpayer who converted in 1998
If a taxpayer converted an IRA to a Roth in 1998 and died in 1999, the remainder of the conversion income is included in the 1999 income, unless the spouse is the beneficiary of the entire Roth IRA. The beneficiary spouse can continue the four year spread. Withdrawals from the Roth IRA by a non spouse beneficiary will not be subject to the 10% penalty, since death is an exception. However if Roth income was withdrawn, it will be subject to income tax since the account is not more than five years old.

Recharacterizing 1999 conversions
You have until October 15, 2000 to recharacterize your 1999 conversion. You can recharacterize either because you have to, or just because you changed your mind. You MUST wait until the end of thirty days after the recharacterization to do a new conversion. Any new conversion will then be deemed to be a 2000 conversion. Any new conversion will then be deemed to be a year 2000 conversion. Partial recharacterizations are also permitted, although the computation then becomes tricky. If you have an account where some assets have increased in value while others have decreased in value, you cannot get the benefit of the decrease by only recharacterizing the losers. The account is viewed as one big pot, and the computation is based on value, not on specific identification of assets.

Rules for recharacterizing 2000 conversions
If you convert an IRA to a Roth in the year 2000 (or later), and then decide to recharacterize back to a traditional IRA, you may not then convert those funds into a Roth IRA until the later of the beginning of the tax year after the tax year of the conversion, or the end of thirty days after the recharacterization. So if a conversion is made in 2000, any recharacterization cannot then be reconverted to a Roth until the beginning of 2001, or thirty one days after the recharacterization, whichever is later. A reconversion made prior to the time permitted is an illegal conversion, and must be recharacterized to avoid destroying the IRA.

Other changes
Changes that would have increased the amount that could be contributed to a Roth IRA, as well as increasing the income threshold for conversions for married couples, was vetoed as part of the 1999 tax reduction bill. It's anybody's guess whether these provisions will be resurrected in 2000. Once again, stay tuned.