Clients, especially those with higher incomes, can and should continue to engage in retirement income planning strategies after reaching their required beginning date for minimum distributions from retirement accounts.
Rollovers and conversions remain valuable even as clients reach retirement age. However, once they reach their RBD, additional complications may arise in executing even the most common retirement planning strategies. To avoid potential penalties, it’s particularly important to understand the interaction between the rules governing RMDs and Roth conversions — and how to correct a situation where a client’s RMD is mistakenly included in a Roth conversion.
RMD obligations must be satisfied before executing a Roth conversion, but that doesn’t mean that clients can’t take their RMD and invest those funds in a Roth. All clients should be advised of Internal Revenue Service ordering rules to avoid penalties upon a conversion.
Roth Conversions and RMDs: The Basics
The basic rule is that a client’s RMD cannot be converted to a Roth or rolled over into another account. That doesn’t mean that the client is prohibited from executing Roth conversions or IRA-to-IRA rollovers. Once clients reach their RBD, they simply must take any RMDs due for the year before they can execute a conversion or a rollover.
Both RMDs and Roth conversions are taxable as ordinary income. Because the RMD and the conversion receive the same tax treatment, it may seem that they’re interchangeable, but that’s not the case. Roth conversions do not satisfy the client’s RMD obligations even though the converted amounts are taxable.
Situations inevitably arise where clients execute a Roth conversion before satisfying their RMD obligations. When evaluating the rules for correcting the mistake — and avoiding a potential 6% penalty if the error is not addressed — it’s important to be aware of the regulations governing excess IRA contributions.
The RMD that was converted is not penalized as a missed RMD. If the amount was treated as a missed RMD, post-Secure 2.0 Act, the penalty amount would equal 25% of the missed RMD. That amount can be reduced to 10% of the missed RMD if the taxpayer takes all missed RMDs and files a tax return paying the required tax and penalty before the earlier of (1) receiving a notice of assessment of the RMD penalty tax or (2) two years from the year of the missed RMD.
Correcting an Excess Roth IRA Contribution
Taxpayers generally have until the due date of their federal income tax return, plus extensions, to correct their mistake. For example, taxpayers who mistakenly converted RMDs during 2024 have until Oct. 15, 2025, to correct their error without application of the 6% penalty. If they don’t correct the mistake, the 6% penalty is imposed for each year that the excess contribution remains in the account.
Assuming that the taxpayer removes the excess from the account by the Oct. 15 deadline, the earnings on the excess must also be removed. Those earnings are known as NIA, or net income attributable, to the excess, and the IRS provides a worksheet to calculate the NIA value. That figure is based on the IRA account balance when the excess was contributed and the account balance at the time the excess is withdrawn.
Importantly, it doesn’t matter how the excess amounts were invested within the Roth account. Calculating the NIA is dependent on the performance of the IRA funds as a whole, not any specific dollars.
From a practical perspective, the excess amounts must be identified as an excess contribution withdrawal so that Form 1099-R can be properly completed. Assuming that the error is corrected before the deadline, no other reporting is necessary. That said, the client must remember that the NIA amounts will be taxable.
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