Recent columns have discussed Roth IRA conversion including some of the pitfalls and mistakes traditional IRA owners make when performing Roth IRA conversions. The 2024 final SECURE Act regulations (released in July 2024) resulted in another ruling that affects traditional IRA owners who want to convert their traditional IRAs to Roth IRAs.
The ruling affects individuals who own multiple traditional IRAs. When a traditional IRA owner reaches his or her required beginning date (RBD) (currently age 73; will increase to age 75 starting January 1, 2035), the traditional IRA owner each year must take a required minimum distribution (RMD) from the traditional IRA. If the individual owns multiple traditional IRAs, then each year the traditional IRA owner must take an “aggregated “ traditional IRA RMD based on the aggregated traditional IRA balance (determined by totaling the account balance of each traditional IRA as of December 31 of the preceding year). Once the “aggregated” traditional IRA RMD is calculated, the traditional IRA owner can fulfill the RMD by taking from any one of the traditional IRAs, or by taking the RMD spread over distributions from more than one of the traditional IRAs.
The ruling coming out of the final SECURE Act regulations affects traditional IRA owners who have reached their RBD and who want in any year to convert some of their traditional IRAs to Roth IRAs. The new law is that before the traditional IRA owner can perform a Roth IRA conversion on any of his or her traditional IRAs, the aggregated traditional IRA RMD must first be taken. This is the case even if the traditional IRAs are held with multiple IRA custodians. Note that aggregation rules imply that RMDs for each traditional IRA must be calculated separately; however, the aggregated RMD total may be taken from any one or more of an individual’s traditional IRAs. In addition, no portion of the aggregated RMD can be rolled over or converted to a Roth IRA.
The annual traditional IRA must be taken prior to any Roth IRA conversion. It is a mistake to complete a Roth IRA conversion before the traditional IRA owner satisfies the entire RMD for the year. Whatever remained of the RMD after a Roth IRA conversion is performed is considered an “excess” contribution to the Roth IRA and, according to IRS rules, must be corrected in a timely fashion in order to avoid an “excess” Roth IRA contribution penalty, equal to six percent of the “excess” contribution.
This new provision coming out of the SECURE Act final regulations was a surprise to many financial advisors. Some financial advisors were under the impression that each traditional IRA “acted on its own” as far as traditional IRA RMD and Roth IRA conversion purposes. These advisors thought that a Roth IRA conversion could be performed on a traditional IRA in which the annual RMD was performed, even though other traditional IRAs are owned. This is not the case now.
It has always been the case that traditional IRA RMDs have to be taken in a particular year before any Roth IRA conversion was performed that year. The difference is that now, all of a traditional IRA owner’s aggregated traditional IRA RMDs must be taken prior to any Roth IRA conversion.
The following three examples illustrate:
Example 1. Larry, age 74 during 2025, owns a traditional IRA(the only traditional IRA he owns). As of December 31, 2024, the account value of Larry’s traditional IRA was $33,630. Larry’s 2025 traditional IRA RMD for 2025 is calculated as follows:
$33,630 (account balance as of 12/31/2024)/25.5 (IRS Uniform Table Life expectancy for a 74-year-old)
= $1,318.82
Before Larry can perform a Roth IRA conversion on his traditional IRA during 2025, he must first take his traditional IRA of $1,318.82.
Example 2. Michelle, age 76, owns two traditional IRAs, IRA A and IRA B. IRA A and IRA B have different custodians. Michelle must withdraw a traditional IRA RMD during 2025. She calculates her 2025 RMD from IRA A to be $32,700 and her 2025 RMD from IRA B will be $14,150. The SECURE Act final regulations require Michelle to take her 2025 aggregated traditional IRA RMD equal to $32,700 plus $14,150, or $46,850. Michele can take the $46,850 RMD only from IRA A, only from IRA B, or from a combination of IRA A and IRA B. She must perform her 2025 RMD of $46,850 before making a Roth IRA conversion on either traditional IRA A or traditional IRA B.
Example 3. Same facts as in Example 2 except that Michelle takes her $32,700 RMD from traditional IRA A but before taking the additional $14,150 distribution from IRA B to satisfy the $46,850 aggregated traditional IRA RMD for 2025, Michelle converts an additional $20,000 from traditional IRA B to a Roth IRA. The unwelcome news is that Michelle performed a Roth IRA conversion before she satisfied her annual RMD from traditional IRA B. The good news is that Michelle was successful in performing a partial Roth IRA conversion equal to $20,000 less $14,150, or $5,850. The remaining $14,150 of the $20,000 conversion performed on traditional IRA B is treated as the remaining portion of Michelle’s $46,850 annual aggregated traditional IRA RMD. That is, of the $20,000 of traditional IRA B that Michele converted to a Roth IRA, only the $5,850 is considered a conversion of IRA B into a Roth IRA. This is because a traditional IRA RMD cannot be converted to a Roth IRA until the annual RMD is satisfied. If the $14,150 would have remained in Michelle’s converted Roth IRA, then the $14,150 would be considered an “excess contribution” and subject to a penalty of six percent of $14,150, or $849.
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In summary, a traditional IRA owner who has reached his or her RBD must satisfy his or her annual aggregated traditional IRA RMD before performing a Roth IRA conversion on any of his or her traditional IRAs. If the annual aggregated traditional IRA is not satisfied before performing a Roth IRA conversion, then any portion of the converted funds that should have been used to satisfy the annual RMD is considered an excess contribution and subject to the IRS’ 6 percent excess Roth IRA contribution penalty.
It should be mentioned that the discussion applies only to traditional IRAs and not to traditional qualified retirement plans, such as traditional 401(k) plans and the traditional TSP.