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Subject:  Re: Roth IRA, WHEN? Date:  1/23/1998  2:31 PM
Author:  TMFTaxes Number:  1480 of 127745

[[In 1998 and 1999, you are in the 28% bracket and roll your regular IRA into a Roth IRA (during
1998). The amount you are going to roll over is $10K. In the year 2000 and 2001 you earn enough
to become a part of the distinguished 31% tax bracket. You will pay 28% tax on 1/4 of the rollover
amount ($2500) during tax years 1998 and 1999, and 31% tax on 1/4 of the rollover amount
during tax years 2000 and 2001. You would pay the 31% (in 2000 and 2001) even if the $10K
added to your AGI for 1998 was still in the 28% tax bracket.]]



Read on for the real rules...
The New Roth IRA - Part II

Last week we received an introduction to the Roth IRA. This week we'll look a look a little closer at some of the other provisions in this new IRA.

Rollover from a regular IRA to a Roth IRA

As most of you know, a rollover from a regular IRA to a Roth IRA is possible if certain provisions are met. First, the rollover must be qualified. The term "qualified rollover" can get a little complex, but it is basically a rollover that meets the 60-day rollover time period, and is not in violation of the "one-year" rollover rules. For additional information regarding qualified rollovers, check out the IRS Publication 590 at the IRS web site (

But, assuming that you can get over the "qualified" distribution rules, you still have one other hurdle to overcome: The Adjusted Gross Income (AGI) limitations. The law states that if your AGI is greater than $100,000, you may NOT make a rollover from a regular IRA to a Roth IRA. This $100,000 limitation applies not only to single filers, but also to married people filing jointing, and head of household filers. But don't think that you can beat the AGI limitations by filing a married-separate tax return: you can't. The law specifically states that if you are a married taxpayer filing a separate tax return, you may NOT rollover your regular IRA to a Roth IRA…regardless of your AGI.

And remember that the AGI limitations are computed without regard to the amount of the rollover. Huh? Well, an example here might be appropriate.

Jack, a single person, has 1998 AGI of $75,000. Jack also has a regular IRA that he wants to rollover to a Roth IRA in the amount of $40,000. For AGI limitation purposes, Jack's threshold is $75,000 (the amount of his "normal" AGI, without regard to the rollover amount), and NOT the combination of his "normal" income and his "rollover" amount. Jack's income tax AGI and taxable income WILL change if he decides to make this rollover, but that's an issue that we'll discuss in detail a little later.

Rollover Taxation Issues

OK…you've decided that you CAN make a rollover. Now you need to know more about the tax issues involved in making the rollover.

In effect, the funds rolled over from the regular IRA to the Roth IRA that would have been taxable had the distribution not been part of a qualified rollover, will be subject to income tax at your normal tax rate…plain and simple. If your IRA consists only of prior deductible contributions and the earnings thereon, the total amount of the rollover will be subject to taxation. If part of your IRA consists of prior non-deductible contributions, they will not be taxed again at the time of the rollover to a Roth IRA. And if your IRA consists of funds from a prior rollover from another qualified pension plan (such as a pension/profit sharing plan, 401k plan, 403b plan, Keogh plan, SEP plan, etc.), all of the funds will be taxable to you at the time of the rollover.

But wait, you mumble. Wasn't there something about spreading the tax over a period of years? Well…kinda. Let's look closer.

The law says that if all or any part of a regular IRA is rolled over to a Roth IRA in a qualified rollover contribution BEFORE January 1, 1999, the amount required to be included in gross income as a result of that rollover contribution MUST be included in gross income ratably over the four tax-year period beginning with the tax year in which the rollover is made.

That sentence is quite a mouthfull, but gives you a lot of information. It says that:

1. A qualified rollover contribution which takes place in 1998 will receive a special tax break. And that special tax break is ONLY available for rollovers which take place in 1998. And this means that the rollover MUST occur in 1998…no later than December 31, 1998…and not a day later. Any rollover from a regular IRA to a Roth IRA that takes place after December 31, 1998 will NOT be allowed this special tax break.
2. The special tax break is that the income that must be reported based on the IRA rollover MUST be spread evenly over a four-year period. Note that it is the INCOME which must be spread over the four tax year period…and NOT the tax itself. Please also note that this spread of income MUST take place…it is NOT an election.
3. This "spread out" income will impact any and all tax issues that are based upon AGI…except for any current or future Roth contribution and/or rollover issues. But your medical expenses (7.5% AGI floor), miscellaneous deductions (2% AGI floor), taxability of social security (based upon AGI), passive loss limitations (based upon AGI) and many, many other tax provisions that use AGI as a guidepost will be impacted. And, in some cases, severely impacted.
4. Because the rollover is "qualified", the 10% penalty for an early withdrawal from an IRA account will NOT be imposed. In effect, the transfer can be made without paying the 10% IRA early withdrawal penalty. But, should you decide to remove your funds "early" from the Roth IRA, you may be subject to an even greater penalty…up to 20% in some cases. We'll discuss this penalty issue in detail next week.

Confused? Well, let's continue with the example of Jack and his rollover. Jack's 1998 AGI is $75,000, and he wants to make a $40,000 rollover from his regular IRA to a Roth IRA. For 1998, Jack's AGI for income tax purposes will be $85,000 (his regular AGI of $75,000 plus one-fourth of his $40,000 rollover amount). In 1999, 2000 and 2001 Jack will add an additional $10,000 (representing his "spread out" of his 1998 rollover) to his normal AGI for that year, and will pay tax on that "spread out" income at his normal tax rate for those years. If Jack delayed his rollover until 1999, this additional $40,000 rollover income would NOT be spread out, but would be added to his normal 1999 AGI and would be taxed in total in 1999. In either case, Jack would NOT be hit with a 10% early withdrawal penalty on the amount of the IRA rolled over to the Roth IRA (assuming Jack keeps his nose clean and doesn't take the funds out of his Roth IRA "early").

And, as mentioned above, all of the tax issues that use AGI for a benchmark (except Roth contributions and rollovers) will now be based upon Jack's new 1998 AGI of $85,000.

So Jack can look forward to paying more tax dollars to Uncle Sammy over the next four tax years. In effect, Jack is trading tax dollars now for the tax free status of the Roth earnings in the future. Is that appropriate? Perhaps for Jack, based upon his personal situation, the answer is yes. But it is certainly NOT appropriate for everybody. In fact, for many people, the rollover of a regular IRA to a Roth IRA may actually cost them tax dollars in the long run.

Which is why the Roth IRA rollover debate has now become very heated. The decision to make this rollover is one that is very personal, based upon personal status, goals, age, intentions, etc., etc., etc. Therefore, the "rollover or not" question can only be answered by you, based upon your personal financial and tax situation.

Next week we'll look at distributions from a Roth IRA, and what impact those distributions may have on your personal tax situation.

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