By Ian Berger
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Late in December, 2021, a taxpayer (under age 59 ½) takes a distribution of his (traditional, not Roth) 401(k), and has 20% withheld for Federal tax. Early in January, 2022, the full 100% of the distribution is deposited in a Roth IRA. Does this avoid the 10% penalty for early distribution? Is this reportable as a Roth conversion in 2022 or 2021?
The 10% early distribution penalty does not apply to Roth conversions. It’s not clear whether the taxpayer converted 80% of the distribution or came up with the funds out-of-pocket to make up the 20% withheld and convert the whole thing. If the taxpayer only converted 80%, then he would owe the 10% penalty on the 20% withheld. The 401(k) plan would report the distribution on a 2021 Form 1099-R, and the taxpayer would be taxed/penalized on the distribution in 2021 (even if the conversion is delayed until 2022). The IRA custodian would report the conversion on a 2022 Form 5498.
I have done a lot of research on this and one’s head can spin as you read the different articles. Hoping you can clear up these two questions.
The Situation: Our 98-year-old mother passed in May, 2022. She had both a Roth IRA and a traditional IRA, and we (her children) were the primary beneficiaries of both IRAs. She passed before taking her 2022 traditional IRA RMD. The broker created inherited Roth and traditional IRAs for us and, during the process, sent us each a check that totaled Mom’s 2022 RMD amount so that her 2022 year-of-death RMD was satisfied.
On our inherited traditional IRAs, we understand that based on February 2022 IRS guidance we need to take annual RMDs from those accounts over 10 years and have the inherited traditional IRAs emptied by the end of the 10th year. With Mom’s 2022 RMD already having been satisfied, is our first RMD year 2022 or 2023? Our understanding is that there are no annual RMDs on our inherited Roth IRAs, but that we must have emptied them by the end of the 10th year. Is our understanding correct?
Thanks for fielding everyone’s questions and sharing your answers. It is a great service!
Appreciate the compliment, and sorry for your loss. These rules are complicated, but you have a good grasp of them. Since Mom died after her RMD required beginning date, the inherited traditional IRAs must be emptied by 12/31/32, and annual RMDs (based on the beneficiary’s single life expectancy) must be taken starting in 2023. The rules are different for the inherited Roth IRAs. Those accounts also must be emptied by 12/31/32, but annual RMDs are not required during the 10-year period because Roth IRA owners are always considered to have died before their required beginning date.