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Does a Roth Conversion Affect My Medicare Premium?

ed slott IRA questions

By Joe Cicchinelli and Beverly DeVeny

This week's Slott Report Mailbag goes through some of the key planning principles discussed in the soon-to-be-released 2015 Retirement Decisions Guide. We answer questions on how Roth conversions affect Medicare premiums, how the rules governing IRA rollovers have changed for 2015 and what individuals who converted to Roth IRAs in 2010 are now free to do with the funds. As always, we recommend you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

1.

Are Roth conversions considered part of normal income for Medicare premium purposes?  For example, if I make a large Roth conversion, can it pump up the rate I have to pay for Medicare Part B and Part D premiums going forward?  This is an important topic for retirees.  Thanks.

Answer:
Yes, a Roth conversion would impact Medicare Part B premiums. Any taxable distribution from a retirement plan is included in ordinary income on the income tax return. But you won’t see the effect immediately. After your tax return is filed, the information is sent to Social Security who then uses it to determine your premium for the following year. So your 2014 conversion is on your tax return prepared in 2015, goes to Social Security in 2015 and impacts your Medicare Part B premium in 2016.

2.

Hi Ed,

I have two IRA accounts with CDs. I am 57 years old and my CDs will both mature in 2015. I just read in another publication that there is a way to avoid penalties by using direct transfers. Can you explain how that works?

Answer:
The 10% early distribution penalty generally applies when you take a distribution payable to yourself before age 59 ½; however the penalty does not apply if you properly roll over the distribution within 60 days. IRA-to-IRA direct transfers are never subject to the 10% early distribution penalty. The funds go directly from one IRA account to another without you touching the money.

More importantly, you can no longer do a 60-day rollover of both of your CD accounts in the same 12-month period. The Tax Court has ruled that this is not allowed under the tax code. Your second rollover will be treated as a taxable distribution and there is no way to fix this. If you put it in an IRA, you will generally have an excess contribution, which is subject to a penalty of 6% per year for every year that it remains in the account.

3.

I’ve been reading a lot of the material online after reading Ed’s The Retirement Savings Time Bomb book. It has been very timely given the fact that my job was recently eliminated.

I would like to run a scenario by you to see if I am grasping the concepts properly.

Assumptions:

  1. Married, filing jointly, we are both 54 in 2015. My wife does not work or have any investment accounts.
  2. Traditional IRA with approx. $1.5m
  3. Roth IRA with approximately $470k
    1. $352K of the $470k was converted in 2010 from the Traditional IRA. The taxes were paid in 2011 and 2012
    2. Five-year rule on the $352k conversion will begin January 1, 2015.

I’m thinking about early retirement and would begin to fund the retirement in the following manner:

  1. Conventional IRA - In Part 3 of the book, where 72(t) basics are reviewed, I believe I could get approximately $67,000 per year.  Of course, this would be taxable income, both federal and state.
  2. Roth IRA – I would withdraw $50K (non-taxable), and convert $100K from my Traditional IRA (taxable approximately $25K).

Question:

  1. Is there any downside to the “step” method I described in #2 where I withdraw $50K every year and use some of the monies to pay the tax on for the “yearly conversion”?

Answer:
Generally, it is best to pay for a conversion using non-IRA assets. By using current Roth assets to pay the tax on future conversions you are depleting your retirement assets and losing future tax-free earnings.  You should speak to an educated advisor who could do some projections for you to determine whether your scenario makes sense.

Regarding your Roth conversion of $352,000 done in 2010, your 5-year holding period ended on January 1, 2015. Those funds can now be withdrawn tax and penalty free. Keep in mind the Roth ordering rules for distributions. Annual contributions are deemed to come out first, then conversions –first in, first out, and lastly, earnings. All Roth IRAs are considered one IRA for purposes of this rule.