Roth conversion question

[REWahoo]

I’m getting ready to convert a traditional IRA to a Roth with the strategy of maximizing my 15% tax bracket. I want to make sure I understand the tax rules on distribution before I pull the conversion trigger.

Farimark.com states “If you're under 59½ and you use your Roth less than five years after a conversion, you may pay the 10% early distribution penalty.” Farimark also discusses taking distributions after five years and under age 59 ½, but I see nothing about the five year rule and distributions after age 59 ½. I’ve also searched the IRS site with no luck.

Here is my question: If I convert a traditional IRA to a Roth and I am more than 59 ½ when converting, do I have to wait five years before taking distributions from the Roth to avoid a 10% tax penalty? I don’t plan on touching the Roth for years, but I do want to understand all of the rules.

[riskadverse]

I've always understood it that you have full access to IRA withdrawals after age 59 & 1/2. (without 10% penalty). I think you also have access to any contributions in a ROTH before that age without penalty. Someone correct me if I'm wrong.

[Mysto]

Tax free qualified distribution must be:

After 59 1/2 - or to your beni after you die / or if you become disabled (exception first time home buyer rule)

Second question - the funds distributed must also meet the 5 tax year requirement even if you are over 59 1/2. But your first contribution starts the 5 year clock going.

So I you started your Roth at 59 - you would have to wait 5 tax years.

Source - fool.com

[Nords]

Originally Posted by REWahoo!

Here is my question: If I convert a traditional IRA to a Roth and I am more than 59 ½ when converting, do I have to wait five years before taking distributions from the Roth to avoid a 10% tax penalty? I don’t plan on touching the Roth for years, but I do want to understand all of the rules.

I'd say "No!" because you're over 59.5, but applying logic to the IRS' guidelines is too risky.

I know that Roth IRA contributions (your basis on Form 8606) can be withdrawn at any time, no matter what your age.

I also know that there are at least three published CPA IRA ferrets experts over at Ed Slott's board who delight in answering this type of question: Mary Kay Foss, Bruce Steiner, and Denise Appleby.

[Martha]

REW, the answer is in this publication:

http://www.irs.gov/publications/p590/index.html

I feel too crappy to read it right now.

Edit: Here is the language:

Distributions of conversion contributions within 5-year period. If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted (the conversion contribution) that you had to include in income. A separate 5-year period applies to each conversion. See Ordering Rules for Distributions, later, to determine the amount, if any, of the distribution that is attributable to the part of the conversion contribution that you had to include in income.

The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion contribution is separately determined for each conversion, and is not necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution. See What Are Qualified Distributions, earlier.

For example, if a calendar-year taxpayer makes a conversion contribution on February 25, 2000, and makes a regular contribution for 1999 on the same date, the 5-year period for the conversion begins January 1, 2000, while the 5-year period for the regular contribution begins on January 1, 1999.

Unless one of the exceptions listed later applies, you must pay the additional tax on the portion of the distribution attributable to the part of the conversion contribution that you had to include in income because of the conversion.

You must pay the 10% additional tax in the year of the distribution, even if you had included the conversion contribution in an earlier year. You also must pay the additional tax on any portion of the distribution attributable to earnings on contributions.

Other early distributions. Unless one of the exceptions listed below applies, you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions.

Exceptions. You may not have to pay the 10% additional tax in the following situations.
You have reached age 59½.

You are disabled.

You are the beneficiary of a deceased IRA owner.

You use the distribution to pay certain qualified first-time homebuyer amounts.

The distributions are part of a series of substantially equal payments.

You have significant unreimbursed medical expenses.

You are paying medical insurance premiums after losing your job.

The distributions are not more than your qualified higher education expenses.

The distribution is due to an IRS levy of the qualified plan.

Most of these exceptions are discussed earlier in chapter 1 under Early Distributions.





Looks to me like you are ok because you are at least 59.5.

[Telly]

My understanding of it follows what Mysto said above. 59 1/2 AND the 5 year period.

Under the url that Martha posted:

http://www.irs.gov/publications/p590/ch02.html#d0e10021

look at:

Roth IRAs > Are Distributions Taxable > What Are Qualified Distributions.

I see this:
----------------------------------------------------------------------------------------
A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

1). It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and

2). The payment or distribution is:

a. Made on or after the date you reach age 59½,

b. Made because you are disabled,

c. Made to a beneficiary or to your estate after your death, or

d. One that meets the requirements listed under First home under Exceptions in chapter 1 (up to a $10,000 lifetime limit).


This image is too large to be displayed in the current screen. Please click the link to view the image.
----------------------------------------------------------------------------

I bolded the logical AND between 1) and 2) for emphasis.

The figure, figure 2-1 that you can click on as the above "image", bears this out:

http://www.irs.gov/publications/p590/15160x04.html


What I have never really understood, when over 59 1/2 for distributing, is EACH Roth that you had started, have it's own 5 year period?

Example - If a person started their first Roth at 55, then started another separate Roth account at 56, do they have to wait for 5 years after 56 to tap the second one without penalty?

And how about adding to a same Roth? Each subsequent conversion amount into the same Roth has it's own 5 year period?

I never really understood this 5 year account business for over 59 1/2 withdrawals.

[Martha]

Telly, I see the language you highlighted--I knew I shouldn't have started reading the publication when I feel like crap.

It looks like both the 5 year rule and the 59.5 rule may apply. Maybe I'll do a bit more poking around. I feel that pub590 is confusing on the issue.

[Mysto]

Please note the 5 year rule applies to "tax years" not calendar years.

[Martha]

I am thinking that there are two different 5 year rules Telly and I are looking at. One is for earnings to be pulled out tax free. For earnings to come out tax free, then you need to have had at least one Roth IRA open for 5 years, plus be 59.5 or meet some other exception. Fortunately, the order of distribution rules have earnings come out after contributions, so you might avoid that tax even within the five years.

The other five year period is for determining whether there is going to be a 10% penalty on distributions taken from the converted Roth. The penalty on the conversion doesn't seem to apply if you are over 59.5.

Continuing to poke around. . .

[Martha]

OK, I am back. I am coming to the conclusion that what I said in my last post is correct. (how is that for self-confidence) See this discussion on the Fairmark site:


http://www.fairmark.com/rothira/distrib.htm

This is how I think it works:

If you are over 59.5 when you withdraw money from your Roth IRA, there will be no 10% penalty, even if you have not had the Roth for 5 years.

However, if you have not had a Roth IRA (any Roth, not necessarily the rollover Roth) for five years, you will have to pay income tax on earnings withdrawn from the Roth, even if you are over 59.5. However, because of order of distribution rules, you take out your contributions and rollover amounts before you take out earnings. Therefore, the chance of owing income taxes is mightly low.


Anyone disagree with me?

[REWahoo]

Great Googledy-moogledy. I thought I was asking a simple question that could be answered with a one line quote from some IRS form. Guess I should have realized nothing is simple when it comes to taxes.

Thanks to all of you for your responses. As I said, I don't plan on touching the converted Roths for several years, so now I'll try to make sure 'several' equals more than five 'tax years'... :P

[riskadverse]

Originally Posted by Martha

OK, I am back. I am coming to the conclusion that what I said in my last post is correct. (how is that for self-confidence) See this discussion on the Fairmark site:


http://www.fairmark.com/rothira/distrib.htm

This is how I think it works:

If you are over 59.5 when you withdraw money from your Roth IRA, there will be no 10% penalty, even if you have not had the Roth for 5 years.

However, if you have not had a Roth IRA (any Roth, not necessarily the rollover Roth) for five years, you will have to pay income tax on earnings withdrawn from the Roth, even if you are over 59.5. However, because of order of distribution rules, you take out your contributions and rollover amounts before you take out earnings. Therefore, the chance of owing income taxes is mightly low.


Anyone disagree with me?

Martha, I think you are correct in your summary. It is a little more complex than I originally thought - ie: you need to have had a (any) Roth IRA for five years and be over 59 & 1/2 to withdraw the earnings portion without penalty.

If I read the Fairmark article correctly, as long as I am over 59 & 1/2 and have had an Roth IRA more than 5 years, I should be able to continue to rollover funds from other IRA's into the Roth and be able to get at the total amount without any penalties.

[pfpelican]

From....http://www.invest-faq.com/articles/r...-roth-ira.html

There is 5-year clock 'A'. Clock 'A' starts on the first day of the first tax year in which any Roth IRA is opened and funded.

Earnings can be withdrawn tax-free and penalty-free after Clock 'A' hits 5 years and a qualifying event (such as turning 59.5, disability, etc.) occurs.

Additional 5-year clocks 'B', 'C', etc. start running for each traditional IRA that is converted to a Roth IRA. Each clock applies just to that conversion.

If you are under age 59.5 when a particular conversion is done, and you withdraw any conversion monies before the clock associated with that particular conversion hits 5 years, you are hit with a 10% penalty on the withdrawn conversion monies.

If you are over age 59.5 when you did the conversion, no penalty no matter how soon you withdraw the monies from that conversion.

[Martha]

Looks like a consensus to me.

[d]

Looks like a consensus

... not till the IRS joins in!