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With all of the conversation going on with regard to Roth IRA Conversions, I thought it would be useful to address a special set of circumstances with regard to Conversions. As the title implies – we’re talking about the eligibility of an IRA for conversion if it is also subject to a Series of Substantially Equal Periodic Payments (SOSEPP), commonly referred to as 72t payments. For background on SOSEPP, you can see the article Early Withdrawal of an IRA – Series of Substantially Equal Periodic Payments.
As you know (if you’re read the article about Penalties for Changing SOSEPP) it can be costly to you if you make a change to your SOSEPP once you’ve set it up. The good news is that a Roth Conversion is NOT considered a “distribution for purposes of determining whether a modification within the meaning of section 72(t)(4)(A) has occurred”, and therefore in itself will not trigger a loss of the penalty-exempt status of the SOSEPP.
What does happen then, in such a circumstance? Well, that’s when things go into the “it depends” category, followed closely by a whole lotta “no guidance from the IRS”.
If you have converted the entire balance of your IRA that is subject to the SOSEPP to a Roth IRA, you will be required to continue taking your series of payments from the new Roth IRA just the same as if they were still coming from the traditional IRA. If you don’t, you will most likely be subjected to recapture penalties on the earlier SOSEPP distributions, unless you’ve reached the end of the distribution requirement period – after five years or age 59½, whichever is later.
On the other hand, if you’ve only converted a portion of the traditional IRA to a Roth IRA, this is where it gets murky. The IRS has not provided definitive guidelines on exactly how you handle the SOSEPP from here… it is abundantly clear that you must continue your series of periodic payments until the end of the distribution period. What’s not clear is if you must continue taking the payments from the remainder of the traditional IRA, or from the Roth IRA, or proportionately from both accounts, or in any amounts you choose from either account, as long as the amount is proper to fit the bounds of your SOSEPP.
The best way to deal with this situation would be to convert the entire account if that’s feasible. If it’s just not feasible, then you should ask for a Private Letter Ruling from the IRS – especially if we’re talking about sizeable amounts (you be the judge). If the possible tax and penalty is relatively minor, I’d suggest taking proportionate amounts from the trad and Roth IRAs until the SOSEPP distribution requirement period ends. Make sure that you keep documentation on all of these transactions – you’ll need it if the IRS comes a-callin’.
Understand that the SOSEPP payment amount is not eligible to be converted to Roth. This is because 72t (SOSEPP) payments are not eligible for rollover. So in any given tax year while the SOSEPP is in effect, you must take the scheduled payment in cash, but then you may convert (or rollover) any additional amount that you like. Just make sure that you continue to take the SOSEPP scheduled payments each year while the SOSEPP is in effect and you should be golden.