1 See Institute Memorandum to Pension Committee No. 40-97 and Pension Operations Advisory Committee
No. 39-97, dated October 10, 1997.
[9806]
March 30, 1998
TO: PENSION COMMITTEE No. 18-98
PENSION OPERATIONS ADVISORY COMMITTEE No. 12-98
AD HOC ROTH IRA COMMITTEE
AD HOC EDUCATION IRA COMMITTEE
RE: SENATE FINANCE COMMITTEE CONSIDERS ROTH AND EDUCATION IRA
TECHNICAL CORRECTIONS
______________________________________________________________________________
The Senate Finance Committee is actively considering legislation to make technical corrections
to the previously enacted Taxpayer Relief Act of 1997. Attached are relevant portions of the Chairman’s
“mark,” which will serve as a basis for Committee discussion. The proposal would change both the
Roth IRA and Education IRA provisions. With regard to the Roth IRA, it differs significantly from the
House technical corrections bill passed last fall, and is generally consistent with positions the Institute
has advocated.1
It is anticipated that the Senate Finance Committee will consider and likely vote on these
technical corrections prior to recess planned for April 10.
I. Roth IRAs The proposal would clarify the following:
A. Conversions
(1) Application of the 4-year spread on income inclusion resulting from a conversion would
be elective;
(2) In the case of conversions to which the 4-year income inclusion rule applies, income
inclusion would be accelerated with respect to amounts withdrawn before the final year
of inclusion; the taxpayer making such a withdrawal would include in income the
amounts otherwise includible under the 4-year rule and also would include the lesser of
(1) the taxable amount of the withdrawal or (2) the remaining taxable amount of the
conversion; in subsequent years, to the extent there are no additional withdrawals, the
amount includible in income under the 4-year spread would be the lesser of (1) the
amount otherwise required under the 4-year rule determined without regard to the
withdrawal or (2) the remaining taxable amount of the conversion (N.B., an example in
the text of the proposal clarifies the mechanics of this rule);
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(3) There would be no separate 5-year aging rule applied to conversion amounts for
purpose of identifying qualified distributions;
(4) If converted amounts, however, are withdrawn within the five-year period beginning
with the year of conversion, then, to the extent attributable to amounts that were
includible in income due to conversion, the amount withdrawn would be subject to an
additional 10 percent penalty, unless an exception to the early withdrawal tax applied;
(5) Ordering rules for withdrawals would deem regular Roth contributions to be withdrawn
first from an account and then converted amounts, with converted amount withdrawals
coming first from the amounts first converted; for purposes of applying the ordering
rules, a taxpayer would aggregate all accounts;
(6) Unlike the House technicals bill, there would be no requirement to establish separate
accounts for conversion amounts.
B. Error Correction
Individuals who erroneously convert IRAs to Roth IRAs or otherwise wish to change the
nature of an IRA contribution may transfer amounts and earnings thereon from any IRA to
another prior to the due date of the taxpayer’s return.
C. Effect of Death on 4-year Spread
Any amounts remaining to be included in income as the result of a 1998 conversion would
be includible in income on the final return of the taxpayer. However, if the surviving spouse
is the beneficiary of the Roth IRA, the spouse would “step into the shoes” of the taxpayer
and include remaining amounts in income over the remainder of the 4-year period.
D. $100,000 AGI Clarification
The proposal would clarify that the conversion amount is not included in AGI when
determining whether a taxpayer is eligible to convert an IRA into a Roth IRA.
II. Education IRA The proposal would clarify the following:
(1) Any balance remaining in an Education IRA would be deemed distributed within 30
days after the date the named beneficiary reaches age 30 or, if earlier, within 30 days of
the date that the beneficiary dies;
(2) The additional 10-percent penalty for non-qualified distributions from an Education
IRA would not apply to a distribution which, while used to pay education expenses, is
includible in the beneficiary’s income solely because the taxpayer elects to claim a
HOPE or Lifetime Learning tax credit;
(3) The 10-percent penalty tax would not apply to the distribution of a contribution to an
Education IRA made during a taxable year if the distribution is made on or before the
date that a return is required to be filed (including filing extensions) by the beneficiary
for the taxable year during which the contribution was made;
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(4) The 6% excise tax penalty would apply each year that an excess contribution remains in
the Education IRA, not only the first year in which the excess contribution was made;
(5) Distributions from Education IRAs would be treated as representing a pro-rata share of
principal and earnings; and
(6) Qualified higher education expenses taken into account when determining the exclusion
under section 530 would not be permitted to be taken into account for a section 162
deduction or section 135 exclusion.
III. Penalty-free IRA Distributions and Hardship Distributions From Qualified Plans
The proposal would provide that distributions from 401(k) plans or other similar arrangements
made on account of hardship are not “eligible rollover distributions” and not subject to the 20-
percent withholding rule applicable to such rollovers. Because they would not be not eligible
rollover distributions, they would not be able to be rolled over into an IRA and distributed under
the IRA’s penalty-free, early withdrawal rules. This proposal would effective for distributions after
December 31, 1998.
Russell G. Galer
Senior Counsel
Attachment