How to handle distributions from IRAs

Kathleen Pender for SF  Gate writes:  Today I've got answers to reader questions on individual retirement accounts and how to handle a reclassified dividend.

Question: Linda L. asks, "My husband and I turn 70 1/2 this year and must begin taking required minimum distributions from our retirement accounts. My husband and I both have traditional IRAs (funded with tax-deductible contributions). Along the way, I opened a new account for IRA contributions that were not deductible. We have always comingled our funds and filed joint tax returns.

"We have been informed that my husband's RMD for 2013 is $56,540. Mine is $30,370 from my regular IRA and $2,100 from my after-tax IRA. That adds up to approximately $89,000 RMD for 2013. I understand that it is to our benefit to make our earliest RMDs from after-tax accounts. Would it be smart to withdraw $48,000 from my after-tax account and $41,000 from our two other accounts?"

Answer: Like many people taking their first required distributions, Linda is unclear on two concepts.

The first is that she and her husband must combine their required minimum distributions.

"Even though they file a joint tax return, it is not a joint distribution requirement," saysJeffrey Levine, an IRA expert with Ed Slott & Co. "The 'I' in IRA stands for individual."

Her husband must take $56,540 from one or more of his IRAs and she must take a total of $32,470 from one or more of her IRAs.

Furthermore, it doesn't matter (from a tax standpoint) whether she takes her distributions from her before-tax or after-tax IRAs. "The IRS looks at all of your IRAs as one giant IRA," Levine says.

If you have both pre- and after-tax money in your IRAs, a portion of your distribution will be tax-free no matter which account or accounts you take your required distribution from. The tax-free percentage is the amount of after-tax dollars in all of her IRAs divided by the total value of all her IRAs.

Question: P.D. writes, "In 2010, I rolled over my traditional IRA into my Roth IRA. Due to making too much, I have not been able to contribute to my Roth for the last three years. My brokerage firm advised me that I can make a contribution to the traditional IRA (but not take a deduction for it), and then immediately roll it into my Roth IRA, as long as I file (the appropriate IRS forms).

"My CPA says technically you can, but that the IRS has taken people to court for doing this and won. Essentially, the IRS said the taxpayer was making a Roth contribution he was not entitled to due to his income level. He was then assessed the 6 percent excise tax for every year the disallowed contribution was allowed to remain in the account. Is this a legal practice, since it is not well defined by the IRS codes?"

Answer: No experts I spoke to had heard of the IRS challenging this strategy in court, but one had heard of cases where it was overturned during an audit.

This has been a popular strategy since 2010, when the income limit on Roth conversions was eliminated. Before 2010, people could not convert if their modified adjusted gross income exceeded $100,000.

They still cannot contribute new money to a Roth IRA if their income is too high, but they can make a nondeductible contribution to a traditional IRA regardless of income. To get around the Roth-contribution limit, some high-income people make a nondeductible contribution to a traditional IRA, then convert it to a Roth.

If they have no other traditional IRAs and make the conversion immediately, they won't owe tax on the transaction because there won't be any untaxed earnings in the traditional IRA. If they do have other traditional IRAs, "the rollover to the Roth IRA is taxable to the extent that there are nontaxed contributions or earnings in the traditional IRAs," saysMark Luscombe, a principal analyst with CCH Tax & Accounting.