By Andy Ives, CFP®, AIF®
IRA Analyst
Anyone with a traditional IRA can do a Roth conversion. As long as the funds are eligible to be rolled over, they can be converted. With a Roth conversion, traditional IRA funds are moved into a Roth IRA. This movement of funds is technically a rollover (as opposed to a transfer) because it is a reportable transaction. The custodian in charge of the traditional IRA will issue a Form 1099-R showing the total dollar amount leaving that IRA in Box 1, Gross distribution. The custodian holding the Roth IRA will issue a Form 5498 reporting the total amount converted in Box 3, Roth IRA conversion amount. Properly coded forms are essential to inform the IRS of what transpired and to track 5-year clocks within the Roth IRA.
When a standard conversion is done between traditional and Roth IRAs held at the same custodian, there are no concerns. The same custodian directly moves the funds between accounts and issues both a 1099-R and a Form 5498. Since the same custodian processed the entire transaction, that custodian is confident handling the tax reporting.
However, some custodians can get a little wary when a Roth conversion is completed via 60-day rollover. This is a perfectly acceptable way to execute a Roth conversion now, and it has been since the beginning of Roth time. A traditional IRA owner is allowed to take a distribution from his account and, within 60 days, roll those dollars over to a Roth IRA. That is a valid Roth conversion — and is sometimes a required necessity. Why so?
Example: John needs cash to make a down payment on a new home. John withdraws $50,000 from his traditional IRA with the intent to roll those dollars back to the traditional IRA within 60 days after his old house is sold. A week later, John realizes he needs $30,000 more to cover the down payment, so he takes a second distribution from his IRA. John quickly sells his old house and wants to roll over the entire $80,000. John learns that the one-rollover-per-year rule prohibits him from rolling back the entire $80,000 to his traditional IRA. John can choose one of the distributions to put back, so he returns $50,000 to the traditional IRA via 60-day rollover. John’s astute advisor knows that Roth conversions do NOT count against the one-rollover-per-year rule. Since John is already stuck with the taxes due on the $30,000, the advisor suggests he roll those dollars directly to a Roth IRA. John does so within the 60-day window. John will receive a Form 1099-R showing an $80,000 distribution, and a Form 5498 reporting $50,000 in Box 2, Rollover contributions, and $30,000 in Box 3, Roth IRA conversion amount.
The key to the example above is that the Roth IRA custodian codes the $30,000 deposit as a Roth conversion. This is essential to generate the proper coding on Form 5498. But some custodians are reticent to report the conversion because they may not know where the dollars originated. Coding this as a “60-day rollover” is incorrect! That would indicate the $30,000 came from another Roth IRA, and it clearly did not. In this example, John completed a valid Roth conversion, and it must be reported as such. Custodians unwilling to do so are creating a potentially mountainous problem for their clients.
If you have technical questions you would like to have answered, be sure to submit them to mailbag@irahelp.com, to be answered on an upcoming Slott Report Mailbag, published every Thursday.
https://irahelp.com/the-roth-conversion-transaction-custodians-dislike/