Fixing a Converted RMD...and the Tax Reporting
What if an RMD gets erroneously converted? Is there a fix? Yes.
Is a Converted RMD a Missed One?
Before we discuss the “fix,” note that there is often a misconception that a converted RMD is a missed RMD. This is not the case. The RMD was taken from the traditional IRA, so no 25% penalty for missing the RMD would apply. Instead, a converted RMD is technically an excess contribution in the Roth IRA, so we follow the excess contribution correction rules. The deadline to fix an excess contribution with no penalty is typically October 15 of the year after the year of the excess. That means that an excess contributions made in 2024 can be corrected with no 6% penalty up until October 15, 2025. If the deadline is missed, then the 6% penalty will apply for every year the excess remains in the account as of December 31. (For example, an excess contribution made in 2024 that is identified and corrected in November of 2025 will have a 6% penalty for 2024 only, because the excess was in the account on December 31, 2024, but removed by December 31, 2025.)
Excess Contributions in IRAs
What about the earnings on the excess contribution while it was illegally in the IRA? Again, we look to the same October 15 deadline in the year after the year of the excess. If the excess contribution is corrected PRIOR to the deadline, the earnings attached to that excess (the “net income attributable,” or “NIA”) must also be removed. If the excess is corrected AFTER the deadline, the NIA (the earnings) can remain in the account. (This is a little odd, but true.)
So, let’s get back to the erroneously converted RMD. In our scenario, the account holder has identified his mistake prior to the October 15 deadline. As such, he is required to remove the excess amount, plus the NIA. Where does he go next?
IRS Publication 590-A provides a worksheet to calculate the earnings on an excess contribution (in this case, on the erroneously converted RMD). The NIA formula is not complicated. You will need to know the account balance immediately before the excess was contributed and the balance on the day the excess is withdrawn. The NIA is determined based on the performance of the entire IRA, not just the investment where the excess was placed. (For example, saying the excess contribution was “sitting in a cash position” within the IRA while the rest of the portfolio skyrocketed does NOT allow the account owner to minimize the NIA.)
Once the NIA is determined, the excess (in this case, the converted RMD) and the NIA must be withdrawn and labeled as an “excess contribution withdrawal.” This will ensure proper coding on the Form 1099-R. Since this correction was made prior to the October 15 deadline, there is no 6% penalty and no need to file any special tax forms (i.e., no Form 5329). However, the earnings will be taxable. How will the taxpayer know what the taxable NIA is? The 1099-R will report a gross distribution in Box 1, and a taxable amount (the NIA) in Box 2a.
A converted RMD is not the end of the world if it is promptly identified and corrected.
By Andy Ives, CFP®, AIF®
IRA Analyst
Ed Slott and Company, LLC
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.