RMD’s and Roth Conversions- Avoid IRS Penalties

by Prof. Robert Bloink and Prof. William H. Byrnes

Clients can—and especially for high-income clients, often should—continue to engage in retirement income planning strategies after reaching their required beginning date (RBD). Rollovers and conversions remain valuable even once the client reaches retirement age. However, once a client reaches their RBD, so is required to take annual required minimum distributions (RMDs) from retirement accounts, additional complications may arise in the course of executing even some of 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.

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 a client has reached their RBD, they must simply 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. It may seem that, because the RMD and the conversion receive the same tax treatment, 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.

Of course, inevitably situations arise where a client executes a Roth conversion before satisfying their RMD obligations. It is possible to correct the mistake and avoid penalties.

Importantly, when evaluating the rules for correcting the error, the rules governing excess IRA contributions apply (exposing the client to a potential 6% penalty if the error is not corrected).

The RMD that was converted is not penalized as a missed RMD. If the amount was treated as a missed RMD, post-SECURE Act 2.0, the penalty amount would equal 25% of the missed RMD (the amount can be reduced to 10% of the missed RMD if the taxpayer takes all of their missed RMDs and files a tax return paying the required tax and penalty amount 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 the Excess Roth IRA Contribution

Taxpayers generally have until the due date of their federal income tax return, plus extensions, to correct their mistake (i.e., October 15 of the year after the excess contribution). For example, taxpayers who mistakenly converted RMDs during 2024 have until October 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 (determined as of December 31).

Assuming the taxpayer removes the excess from the account by the October 15 deadline, the earnings on the excess must also be removed. The earnings are known as NIA, or net income attributable, to the excess. The IRS provides a worksheet to allow taxpayers to calculate the NIA value, which 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 actual 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 the error is corrected prior to the deadline, no other reporting is necessary. That said, the client must remember that the NIA amounts will be taxable (the client’s Form 1099-R will identify both the taxable and non-taxable amounts).

Conclusion

Clients should understand that their RMD obligations must be satisfied before executing a Roth conversion—but that doesn’t mean they can’t take their RMD and invest those RMD funds in their Roth (assuming the client is entitled to directly contribute to a Roth, based on the annual income limits). All clients should be advised of the IRS ordering rules to avoid penalties upon executing a conversion.