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THE PRO-RATA RULE & IRA BENEFICIARIES: TODAY’S SLOTT REPORT MAILBAG

By Andy Ives, CFP®, AIF®
IRA Analyst

Question:

Hi. My name is John and I have a Roth question. I have read your most recent book but did not find the answer to this question. I have made non-deductible contributions to a traditional IRA for many years, so about half of the account is basis. I have no Roth account (yet). I recently left my job and rolled over my 401(k) into a separate rollover IRA. Will I have to include this rollover IRA along with the traditional IRA as part of the pro-rata rule in order to take advantage of Roth conversions? Hopefully, I did not screw up by removing funds from my prior employer.

Thanks for your help,

John

Answer:

John,

Please don’t shoot the messenger, because the answer is not what you want to hear. Yes, you will have to include your “rollover IRA” in the pro-rata calculation. The IRS dictates that you must include all of your traditional IRAs, SEP and SIMPLE plans when doing the pro-rata math for a Roth conversion. It does not matter if these accounts are held at different institutions. Sadly, had you left the 401(k) dollars in the plan until the year after the Roth conversion, they would not have counted in the pro-rata calculation.

Question:

I would appreciate your views on the following scenario. IRA owner over the age of 72 has children who are not good with money. Owner anticipates dying in the next few years. If his kids are the beneficiaries of his estate, and if he names his estate as beneficiary of his IRA, then will the executor of his estate be able to disperse the IRA over the remaining “lifetime” of the deceased, thus controlling (more or less) the distribution of his IRA to the children? I realize it will eventually run out, but the IRA owner may appreciate that his kids will not have immediate access to all of the IRA.

Thanks in advance for your guidance and comments.

Doug

Answer:

Doug,

While this plan could work, it has the potential to fall apart. Yes, an estate as a non-designated beneficiary (and since the IRA owner is over the age of 72) would require RMDs to be paid to the estate from the estate-owned inherited IRA. The estate would then disseminate the RMD to the beneficiaries of the estate. However, an RMD is just that – a minimum payment. A person could always take more. This plan would require a strong and independent executor of the estate to rigidly adhere to the annual RMD schedule. To further complicate things, unhappy beneficiaries eager to get higher payouts could even mount legal challenges. Such a plan would also require the estate to stay open (adding additional expenses) for a number of years. A trust would probably be a better option. Trusts can be specifically designed to prevent spendthrift children from burning through accounts. The trustee of the trust could be allowed to distribute any amount annually, or none at all. This could continue in perpetuity. Granted, the IRA would need to be emptied within 10 years based on SECURE Act guidelines, and anything remaining in the trust after that time would get hit with high trust tax rates. Nevertheless, with a trust, you could extend the father’s hold on the assets beyond the 10-year period and beyond his single life expectancy.

https://www.irahelp.com/slottreport/pro-rata-rule-ira-beneficiaries-todays-slott-report-mailbag

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Investment advisory services are offered through Foundations Investment Advisors, LLC and is a SEC registered investment advisor.

Investment advisory services are offered through Donato Wealth Management and is a SEC registered investment advisor.