Quick Roth Conversion Tax ?

[Mike Piper]

A forum member emailed me to ask if I would reply to this thread.

Quote:

The thread relates to the idea of doing a Roth conversion and having federal income tax withheld and then within the 60-day window depositing from other sources the amount withheld into the Roth as an "indirect rollover". So for example, one would do a $10k Roth conversion with $2k withheld in federal income tax and then within the 60 day window deposit $2k of money from other sources into the Roth... so $10k ends up out of the tIRA, $10k ends up in the Roth and $2k is paid in tax to the feds. The nuance of a difference between doing this and just a $10k Roth conversion with no withholding and separately making a $10k estimated payment is that the $10k withheld is considered as having been paid ratably over the year for prepayment penalty purposes.

I agree that using other assets to essentially make the conversion "complete" within 60 days is fine -- the whole amount will count as having been converted.

And yes, the amount withheld will count as having been paid over the course of the year.


As far as references for the 60-day option, here's a relevant Treasury Regulation. (Of note, it refers to a MAGI limitation which no longer exists.)
https://www.law.cornell.edu/cfr/text/26/1.408A-4


Here are the referenced 408A(e) and 408(d)(3)
https://www.law.cornell.edu/uscode/text/26/408A#e
https://www.law.cornell.edu/uscode/text/26/408#d_3


IRS Publication 590a mentions the concept as well.
https://www.irs.gov/publications/p59...link1000230658

[SecondCor521]

Quote:

Originally Posted by fritz On this thread there are also questions on the 5 year rule for conversions. I understand that the IRS sees Roth conversions as FIFO (first in - first out), and co-mingling of funds really isn't an issue (as they see it). But I plan on doing Roth conversions annually until it's all converted, or the other scenario happens. Plans might change if the govt. tax game board changes (again), but have to go the direction dealt currently. Given "you" have a 5 year time frame for any Roth conversion withdrawals w/o 10% in penalties (and being +59.5 yrs age) - I thought to do annual Roth conversions into my existing Roth account, and place each year's conversion funds into a specific separate Mutual fund for the 5 years. This would be for isolating the conversions for timing and preventing commingling of conversion funds and earnings. I see this as important for heirs, as the 5 year rule is not forgiven upon the death of the original owner, but understand the 10% penalty is forgiven for all heirs. Also understand heirs would be responsible for taxes on "earnings only" for all withdrawals of conversions not meeting the 5 year rule. This could affect up to five conversions under timers. Spouse has the rollover option, and my children/grandchildren beneficiaries (not falling under the special circumstances for stretch IRA rules) have 10 years to remove the funds. They have the option of holding the funds until the original 5 year timers are met, or paying taxes on the earnings since the conversions. Holding them in separate funds until the 5 year timers are met should greatly simplify things for them tax-wise, should the other scenario happen and my heirs (other than my spouse) inherit the account. Am I looking at this correctly?

I think mostly so, with one major note of caution.

When determining contributions and conversions with IRAs, the IRS looks at dollars, not how those dollars are invested inside the accounts.

Suppose you do a Roth conversion of $10,000 in 2021 and put it all in mutual fund X. Five tax years later in 2026, suppose the value of those mutual fund shares is now $17,000. You may only withdraw $10,000 (the dollar value of the conversion in 2021) from your Roth IRA tax- and penalty-free, not the $17,000 (the value to which the investment had grown). The additional $7,000 worth of shares would be considered earnings, which are last in the Roth ordering rules and would come out order-wise after any 2022, 2023, 2024, and 2025 Roth conversions, and would be subject to penalties and maybe taxes if withdrawn before 59.5.

[fritz]

Quote:

Originally Posted by SecondCor521 I think mostly so, with one major note of caution. When determining contributions and conversions with IRAs, the IRS looks at dollars, not how those dollars are invested inside the accounts. Suppose you do a Roth conversion of $10,000 in 2021 and put it all in mutual fund X. Five tax years later in 2026, suppose the value of those mutual fund shares is now $17,000. You may only withdraw $10,000 (the dollar value of the conversion in 2021) from your Roth IRA tax- and penalty-free, not the $17,000 (the value to which the investment had grown). The additional $7,000 worth of shares would be considered earnings, which are last in the Roth ordering rules and would come out order-wise after any 2022, 2023, 2024, and 2025 Roth conversions, and would be subject to penalties and maybe taxes if withdrawn before 59.5.

Being subject to taxes and penalties on earnings withdrawals applies to when you're under the age of 59.5?

If I understand your stated withdrawal order process (IRS) -

The only thing available to someone doing yearly Roth conversions (after the 5 year timer is satisfied) is the initial conversion amount. The earnings on that conversion come out in the order the IRS follows as if all conversions were commingled. The IRS would follow the FIFO order (first in - first out) for contributions/conversions, and then any earnings follow (last) in the order of things.

Following this withdrawal order process - you would never be able to access any Roth contributions/conversions earnings until all of your conversions had lapsed their 5 year timers?

If you were doing yearly Roth conversions (even with required RMDs) to level out your IRA's future RMD annual withdrawals (reducing the amount of your RMDs as you age) - you'd never be able to access any earnings on any of your Roth contributions/conversions, until the last Roth conversion's 5 year timer had lapsed? (This may be five years after your death.)

Our Roth accounts are decades old (and we're over the age of 59.5), and without any past/current Roth conversions - all of the funds (including earnings) are available for withdrawal.

If we should do any Roth conversions into those accounts - your stating that those contributions/conversions earnings would then be frozen for for tax-free accessing, until all Roth conversion 5 year timers have lapsed?

If doing yearly Roth conversions - your heirs would have to wait until the last Roth conversion's timer had lapsed, to access any/all earnings w/o incurring federal taxes?

I don't recall coming across any verbiage on the 5 year rule regarding earnings on all Roth conversions (and contributions) being inaccessible for tax-free withdrawal until all Roth conversion 5 year timers have lapsed.

Appreciate if you would point out where this information is accessible online. Really hamstrings Roth conversions..

[SecondCor521]

^ The rules are complicated, and I think you still have some misunderstandings.

The rules depend on when you opened your first Roth IRA, and whether or not you are past age 59.5. The rules may also depend on whether it is an inherited Roth IRA. I understand the rules far enough to apply them to my own situation; beyond that I'll point you to the IRS website for further information.

For original owners of a Roth IRA and setting aside inherited Roth IRAs for a minute:

The easiest way to understand it is that there are three buckets: contributions, conversions, and earnings. Contributions are the dollar amounts you put into your Roth IRA. Conversions are the dollar amounts you converted, usually from a traditional IRA. Earnings are all the dollars that are not contributions or conversions.

Inside your Roth IRA, the IRS totally does not care what you bought when, or how much, or if there are dividends, or interest, or capital appreciation or depreciation. Reread the previous paragraph - they only care how many dollars you put in, how many dollars you converted in, and the rest of the dollars are earnings.

You can have any number of Roth IRAs and make contributions and conversions to any of them. From the IRS' point of view, they treat all your Roth IRAs as one giant Roth IRA.

When money is removed from the Roth IRA, the IRS deems that contributions come out first. Contributions are not taxed and are not penalized ever. Contributions are deemed to be removed in FIFO order.

Once all contributions to the Roth IRA have been removed, then the IRS deems that conversions come out second, again in FIFO order. Conversions that have rested in the Roth IRA for five tax years can be removed tax- and penalty-free, even if you are under 59.5.

I am not sure if one can remove conversions faster than the five year timeline implies without penalty after age 59.5. It may be so.

If you withdraw enough fast enough to where you are withdrawing conversion amounts before they have rested for five years, I am not sure what happens exactly but I think the 10% penalty applies. If you want to call that "frozen", I suppose you could, but I wouldn't think of it that way - the money is accessible, there may just be penalties due.

After you have removed all contribution amounts and conversion amounts, then the IRS deems that you are taking out earnings (that's the only thing left). Earnings removed before age 59.5, as I noted before, may be subject to taxes and penalties. I am 99.9% certain that earnings removed after age 59.5 and five years after your first Roth IRA was opened are both tax and penalty free.

Note the following things about the ordering rules:

1. The IRS sets the ordering rules, and you can't elect differently.
2. The IRS ordering rules actually happen to usually be the approach most people would want to follow anyway.
3. The IRS ordering rules don't care about what happens inside your Roth IRA. There is no sort of tracing of investments. So if you make a contribution in year 1 and buy stock X with your contribution dollars, and then a conversion in year 2 and buy stock Y, then make a withdrawal in year 3, the IRS doesn't care if you sell stock Y to fund the withdrawal; it will be considered a withdrawal of the contributions from year 1 because contributions come out before conversions.

For inherited Roth IRAs, I believe that the ordering rules still apply but that there may be relief from the 10% penalty if the original owner had opened their Roth IRA more than five years ago and was over 59.5 when they passed away. I think this Marketwatch article is reasonably understandable and is probably accurate: https://www.marketwatch.com/story/if...xed-2021-01-21

For where this is available online, I would point you to the instructions for IRS Form 8606, which are located at https://www.irs.gov/pub/irs-pdf/i8606.pdf. Roth withdrawals, in particular, are covered in part III of that form. The five year rule is sort of hidden in the basis calculation for line 24 of that form. These instructions are very complicated because they have to deal with a lot of scenarios which I have left out.

(*) Assuming you don't have any basis in your traditional IRA. If you have a basis in your traditional IRA, it's probably because you made non-deductible contributions at some point. There are ordering rules for these as well, but I don't know what they are, because this situation does not apply to me.

[Mike Piper]

SecondCor521, you have written an excellent explanation. Just providing confirmation of a few points, below.

Quote:

Originally Posted by SecondCor521 I am not sure if one can remove conversions faster than the five year timeline implies without penalty after age 59.5. It may be so.

Yes, after reaching age 59.5, converted amounts can come out penalty-free regardless of the 5-year window.

Quote:

Originally Posted by SecondCor521 If you withdraw enough fast enough to where you are withdrawing conversion amounts before they have rested for five years, I am not sure what happens exactly but I think the 10% penalty applies. If you want to call that "frozen", I suppose you could, but I wouldn't think of it that way - the money is accessible, there may just be penalties due.

That's correct. The money is accessible. And it would not be subject to ordinary income tax. It would be subject to the 10% penalty, unless the distribution is for a qualifying reason (e.g., you are age 59.5, deceased, or disabled) or the distribution meets one of the other exceptions to the 10% penalty (e.g., it's used to pay for qualifying higher education expenses).

IRC 408A(d) and 72(t) are relevant here:
https://www.law.cornell.edu/uscode/text/26/408A#d
https://www.law.cornell.edu/uscode/text/26/72#t_

Quote:

Originally Posted by SecondCor521 After you have removed all contribution amounts and conversion amounts, then the IRS deems that you are taking out earnings (that's the only thing left). Earnings removed before age 59.5, as I noted before, may be subject to taxes and penalties. I am 99.9% certain that earnings removed after age 59.5 and five years after your first Roth IRA was opened are both tax and penalty free.

Yep.

Quote:

Originally Posted by SecondCor521 For inherited Roth IRAs, I believe that the ordering rules still apply but that there may be relief from the 10% penalty if the original owner had opened their Roth IRA more than five years ago and was over 59.5 when they passed away.

The 10% penalty is waived simply because the owner has passed away and the distribution is being made to the beneficiary or to the owner's estate. Doesn't matter if the 5-year rule was met, nor does the deceased owner's age matter.

See 72(t)(2)(A)(ii)
https://www.law.cornell.edu/uscode/text/26/72#t_

[fritz]

I originally asked if the penalties and taxes SecondCor521 was referring to applied to those under 59.5. I went on to describe if not - why I then found the ordering rules to conflict with the 5 year rules.

I thought the "separate" 5 year rules for Roth contributions and Roth conversions were in place to govern what was a qualified distribution and a non-qualified distribution.

Distributions from a Roth account that was open for 5 years from the 1st contribution, came under a qualified distribution - providing the owner was over 59.5 years of age. All contributions and "earnings" were qualified distributions and not subject to penalties or taxes.

Distributions from a Roth account that affected any Roth "conversions" were considered qualified distributions - if that specific Roth conversion's 5 year timer had lapsed. All contributions and "earnings" from that specific Roth conversion were then qualified distributions and not subject to penalties or taxes.

I also thought the ordering rules really come into play when the Roth account distribution goes beyond what's considered qualified distributions and then becomes a non-qualified distribution.

Non-qualified distributions would be -

After all qualified contributions/earnings were taken from a +5 year old Roth account, along with all contributions/earnings from conversions older than 5 years.

If this is correct - only the non-qualified contributions and then earnings would follow the ordering rules and be subject to taxes and penalties.

As I see it - that would leave Roth conversions that had yet to meet their 5 year rule timers in place.

My separating Roth conversions in funds over 5 years in my original post, was for tracking simplicity of the 5yr timers (for heirs, should I pass while the timers are active).

[SecondCor521]

Quote:

Originally Posted by fritz I also thought the ordering rules really come into play

My understanding is that ordering rules are always in play. Always. It doesn't matter your age. It doesn't matter whether it's an originally owned or inherited IRA. It doesn't matter how long you've had a Roth IRA. It also doesn't matter if you like the ordering rules or agree with them or not. It also doesn't matter whether you've made contributions or conversions or both. The ordering rules are always in play.

Quote:

Originally Posted by fritz All contributions and "earnings" from that specific Roth conversion were then qualified distributions and not subject to penalties or taxes.

I'm not sure how you're assigning meaning to the terms qualified and unqualified. The IRS doesn't use such language, so I think it's confusing to introduce it.

I think what may be messing up your understanding is referenced in the above quote. It seems that you want to associate a given Roth conversion with its subsequent earnings inside the Roth. This is not how the IRS sees it, and it's what I've been trying to say (apparently not that successfully) in my previous posts.

So let me try again.

Assume you start with a Roth with $0 in it that you opened in 2015.

If you convert $10K into your Roth this year, then two things will happen. First, you add $10K to your gross income which will show up on your 2021 Form 1040 line 4b. Second, you can take $10K out of your Roth on 1/1/2026 or later tax- and penalty-free.

If you take that $10K and use it to buy an investment that grows to $17K, then the additional $7K is considered earnings by the IRS and goes into the third bucket.

And per the ordering rules, you can't take that $7K out of that third bucket until you take out everything in the first bucket (contributions) and everything out of the second bucket (conversions). Even if, in your head, they're connected because they happen to be the same mutual fund shares inside the Roth - again, the IRS doesn't care about what happens inside your Roth. They do not connect dollars with investments.

So to specifically respond to the above sentence of yours that I quoted:

1. If the original Roth owner is under 59.5, the earnings on a particular Roth conversion do not become penalty-free just because the conversion amount itself has become qualified by way of the 5-year holding period.

2. If the original Roth owner is over 59.5, the conversions and earnings are (as MikePiper helpfully confirmed, above) penalty-free regardless of the 5-year conversion timer. (I think the other 5-year rule applies, though, so you'd have had to have had a Roth account opened at least five years.)

3. If the original owner has died, the conversions and earnings are (again, hat tip to Mike Piper for confirming above) again penalty-free regardless of the 5-year timer. (The other 5-year rule does apply, according to the MarketWatch article above; Mike Piper seems to say the opposite, but I think he's referring to the 5-year conversion timer rule, not the have-a-Roth-open-five-years-ago rule.)

Since we're getting rather detailed and it's possible we may continue to talk past each other, I might suggest that you present the most simple concrete example illustrating your question or point. Then we could probably tell you with reference to that example what's up.

[Mike Piper]

Contributions come out tax-free, penalty-free at any time.

Conversions come out free from regular income tax at any time. There is, however, a 10% penalty unless:
a) the 5-year rule has been met for that conversion,
b) the distribution is for a qualifying reason, or
c) one of the other exceptions provided in 72(t) applies.

As far as earnings:
1) they are tax-free and penalty-free if there is a qualifying reason and the 5-year rule has been met;

2) they are taxable as income but not subject to the 10% penalty if
2a) the distribution is for a qualifying reason but you have not met the 5-year rule or
2b) the distribution is not for a qualifying reason but one of the other exceptions in 72(t) applies;

3) they are taxable as income and subject to 10% penalty if the distribution was not for a qualifying reason and none of the other exceptions to the 10% penalty from 72(t) is applicable.

Qualifying reasons:
a) you are age 59.5,
b) you are disabled,
c) you are deceased and the distribution is being paid to the account's beneficiary or to your estate, or
d) the distribution is a "qualified first-time homebuyer distribution."

[fritz]

Quote:

Originally Posted by Mike Piper Contributions come out tax-free, penalty-free at any time. Conversions come out free from regular income tax at any time. There is, however, a 10% penalty unless: a) the 5-year rule has been met for that conversion, b) the distribution is for a qualifying reason, or c) one of the other exceptions provided in 72(t) applies. As far as earnings: 1) they are tax-free and penalty-free if there is a qualifying reason and the 5-year rule has been met; 2) they are taxable as income but not subject to the 10% penalty if 2a) the distribution is for a qualifying reason but you have not met the 5-year rule or 2b) the distribution is not for a qualifying reason but one of the other exceptions in 72(t) applies; 3) they are taxable as income and subject to 10% penalty if the distribution was not for a qualifying reason and none of the other exceptions to the 10% penalty from 72(t) is applicable. Qualifying reasons: a) you are age 59.5, b) you are disabled, c) you are deceased and the distribution is being paid to the account's beneficiary or to your estate, or d) the distribution is a "qualified first-time homebuyer distribution."

I believe you stated the same things I did (post #123), only I used more of the king's English to to say it.

[fritz]

Quote:

Originally Posted by SecondCor521 My understanding is that ordering rules are always in play. Always. It doesn't matter your age. It doesn't matter whether it's an originally owned or inherited IRA. It doesn't matter how long you've had a Roth IRA. It also doesn't matter if you like the ordering rules or agree with them or not. It also doesn't matter whether you've made contributions or conversions or both. The ordering rules are always in play. I'm not sure how you're assigning meaning to the terms qualified and unqualified. The IRS doesn't use such language, so I think it's confusing to introduce it. I think what may be messing up your understanding is referenced in the above quote. It seems that you want to associate a given Roth conversion with its subsequent earnings inside the Roth. This is not how the IRS sees it, and it's what I've been trying to say (apparently not that successfully) in my previous posts. So let me try again. Assume you start with a Roth with $0 in it that you opened in 2015. If you convert $10K into your Roth this year, then two things will happen. First, you add $10K to your gross income which will show up on your 2021 Form 1040 line 4b. Second, you can take $10K out of your Roth on 1/1/2026 or later tax- and penalty-free. If you take that $10K and use it to buy an investment that grows to $17K, then the additional $7K is considered earnings by the IRS and goes into the third bucket. And per the ordering rules, you can't take that $7K out of that third bucket until you take out everything in the first bucket (contributions) and everything out of the second bucket (conversions). Even if, in your head, they're connected because they happen to be the same mutual fund shares inside the Roth - again, the IRS doesn't care about what happens inside your Roth. They do not connect dollars with investments. So to specifically respond to the above sentence of yours that I quoted: 1. If the original Roth owner is under 59.5, the earnings on a particular Roth conversion do not become penalty-free just because the conversion amount itself has become qualified by way of the 5-year holding period. 2. If the original Roth owner is over 59.5, the conversions and earnings are (as MikePiper helpfully confirmed, above) penalty-free regardless of the 5-year conversion timer. (I think the other 5-year rule applies, though, so you'd have had to have had a Roth account opened at least five years.) 3. If the original owner has died, the conversions and earnings are (again, hat tip to Mike Piper for confirming above) again penalty-free regardless of the 5-year timer. (The other 5-year rule does apply, according to the MarketWatch article above; Mike Piper seems to say the opposite, but I think he's referring to the 5-year conversion timer rule, not the have-a-Roth-open-five-years-ago rule.) Since we're getting rather detailed and it's possible we may continue to talk past each other, I might suggest that you present the most simple concrete example illustrating your question or point. Then we could probably tell you with reference to that example what's up.

I took the definitions from this info -

https://www.irs.gov/retirement-plans...-distributions

[SecondCor521]

Quote:

Originally Posted by fritz I took the definitions from this info - https://www.irs.gov/retirement-plans...-distributions

You were right on this; I stand corrected. Thank you.

ETA: However, that page seems to be describing Roth 401(k) accounts, not Roth IRAs. Although the two share the name and a general approach of after-tax contributions and tax-free growth, the tax treatment of the two account types are different in some ways.

I would not assume that anything you read about a Roth 401(k) applies to a Roth IRA or vice versa.

Everything I've been writing on this thread has been assuming Roth IRAs, not a Roth 401(k). I think Mike Piper was also making the same assumption.

[fritz]

Quote:

Originally Posted by SecondCor521 You were right on this; I stand corrected. Thank you. ETA: However, that page seems to be describing Roth 401(k) accounts, not Roth IRAs. Although the two share the name and a general approach of after-tax contributions and tax-free growth, the tax treatment of the two account types are different in some ways. I would not assume that anything you read about a Roth 401(k) applies to a Roth IRA or vice versa. Everything I've been writing on this thread has been assuming Roth IRAs, not a Roth 401(k). I think Mike Piper was also making the same assumption.

I've seen these qualified/non-qualified Roth distributions references in other online articles.

https://smartasset.com/retirement/ro...d-distribution

But you stated the IRS didn't use it, and I recalled seeing it on their website recently (the other link - post #130).

Please understand - I'm not looking to disagree with anyone posting here. Apologize if it's coming across that way.

I'm planning on implementing everything I've posted on this thread, this year (possible multiple Roth conversions, custodian withholding federal taxes, placing that tax amount withheld into my Roth (separate fund) within the 60-day rule with funds from another source, and placing yearly Roth conversions in my Roth account in separate funds for tracking each conversion's 5 year timer). I was running my plan by members here (for comments/corrections) to see if my ducks are all in a row - for the most part.

No one responded when i asked if anyone could confirm if my Roth conversion strategy was correct (post #103) when it was questioned by a friend of mine knowledgeable in finance, so I searched and found a credible answer. I posted what I found here (post #116) for everyone who's following the thread. I included the credible references they gave as well.

My harebrained idea for tracking the 5 year rule timers on yearly Roth conversions seemed logical (to me). I was pretty sure that the way I looked at Roth account distributions on contributions, conversions, and earnings as it related to qualified and non-qualified for taxes and penalties was close to being right. Mike Piper's post (#128) appears to corroborate my post #126

[SecondCor521]

Quote:

Originally Posted by fritz I've seen these qualified/non-qualified Roth distributions references in other online articles. https://smartasset.com/retirement/ro...d-distribution But you stated the IRS didn't use it, and I recalled seeing it on their website recently (the other link - post #130). Please understand - I'm not looking to disagree with anyone posting here. Apologize if it's coming across that way. I'm planning on implementing everything I've posted on this thread, this year (possible multiple Roth conversions, custodian withholding federal taxes, placing that tax amount withheld into my Roth (separate fund) within the 60-day rule with funds from another source, and placing yearly Roth conversions in my Roth account in separate funds for tracking each conversion's 5 year timer). I was running my plan by members here (for comments/corrections) to see if my ducks are all in a row - for the most part. No one responded when i asked if anyone could confirm if my Roth conversion strategy was correct (post #103) when it was questioned by a friend of mine knowledgeable in finance, so I searched and found a credible answer. I posted what I found here (post #116) for everyone who's following the thread. I included the credible references they gave as well. My harebrained idea for tracking the 5 year rule timers on yearly Roth conversions seemed logical (to me). I was pretty sure that the way I looked at Roth account distributions on contributions, conversions, and earnings as it related to qualified and non-qualified for taxes and penalties was close to being right. Mike Piper's post (#128) appears to corroborate my post #126

No worries here. I'm mainly trying to make sure I present accurate information and secondarily to try to help you. If I'm not being helpful, feel free to tell me to stop trying.

I will say that in your response I think that you emphasized a relatively minor part of my post #127 (about IRS terminology) and ignored the main point of it (how the IRS treats conversion earnings). I'm still not convinced that you understand my main point, especially since you reiterate again that you plan to track your 5 year timers with different investments in your last paragraph in the above quoted section.

Here's the main point that I'm not sure you're getting:

"Assume you start with a Roth with $0 in it that you opened in 2015.

If you convert $10K into your Roth this year, then two things will happen. First, you add $10K to your gross income which will show up on your 2021 Form 1040 line 4b. Second, you can take $10K out of your Roth on 1/1/2026 or later tax- and penalty-free.

If you take that $10K and use it to buy an investment that grows to $17K, then the additional $7K is considered earnings by the IRS and goes into the third bucket.

And per the ordering rules, you can't take that $7K out of that third bucket until you take out everything in the first bucket (contributions) and everything out of the second bucket (conversions). Even if, in your head, they're connected because they happen to be the same mutual fund shares inside the Roth - again, the IRS doesn't care about what happens inside your Roth. They do not connect dollars with investments."

[fritz]

Quote:

Originally Posted by SecondCor521 No worries here. I'm mainly trying to make sure I present accurate information and secondarily to try to help you. If I'm not being helpful, feel free to tell me to stop trying. I will say that in your response I think that you emphasized a relatively minor part of my post #127 (about IRS terminology) and ignored the main point of it (how the IRS treats conversion earnings). I'm still not convinced that you understand my main point, especially since you reiterate again that you plan to track your 5 year timers with different investments in your last paragraph in the above quoted section. Here's the main point that I'm not sure you're getting: "Assume you start with a Roth with $0 in it that you opened in 2015. If you convert $10K into your Roth this year, then two things will happen. First, you add $10K to your gross income which will show up on your 2021 Form 1040 line 4b. Second, you can take $10K out of your Roth on 1/1/2026 or later tax- and penalty-free. If you take that $10K and use it to buy an investment that grows to $17K, then the additional $7K is considered earnings by the IRS and goes into the third bucket. And per the ordering rules, you can't take that $7K out of that third bucket until you take out everything in the first bucket (contributions) and everything out of the second bucket (conversions). Even if, in your head, they're connected because they happen to be the same mutual fund shares inside the Roth - again, the IRS doesn't care about what happens inside your Roth. They do not connect dollars with investments."

Everything you've re-stated here from your original post, I agreed with. When you stated the IRS didn't use qualified and non-qualified distribution terminology, I just referenced where I saw it (IRS) for the followers of this thread, and it was not meant to call you out on it. I've seen this terminology used for Roth conversions in other online places.

As for the ordering rules - I put together my post #126 regarding what was qualified and non-qualified for a Roth distributions, from my understanding of the information from several online references (two of them).

https://www.investopedia.com/terms/o/orderingrules.asp

https://www.doughroller.net/retireme...a-conversions/

My understanding (and for simplicity) is that qualified distributions - those that meet both of the 5 year rules (for contributions/earnings, and conversions/earnings), may be withdrawn penalty and tax free. The ordering rules place those funds within the Roth as penalty and tax free for distribution, once the 5 year rules are both met (if in fact you have done any Roth conversions).

It stands to reason that the 5 year rule for contributions/earnings on Roths comes first - that the account has to be open for 5 years and the person must be over the age of 59.5. I also understand that you may have more than one Roth account, but as long as one account has been open for 5 years and you are over 59.5 years of age, you've also met the 5 year rule (the IRS sees your accounts as one).

The 5 year rule on distributions from Roth conversions is an additional rule that applies to all conversions - where the conversions/earnings are considered qualified distributions after each conversion's 5 year timer has lapsed, the 5 year rule for contributions/earnings would have also been met.

I did state the ordering rules really come into play (post #126) after all qualified distributions were withdrawn (again, following the ordering rules).

I also thought the ordering rules really come into play when the Roth account distribution goes beyond what's considered qualified distributions and then becomes a non-qualified distribution.

As I see it, the taxes and penalties (and the IRS) come into play with non-qualified distributions, and follow the ordering rules for taxes and penalties on contributions/earnings (first 5 year rule), and then contributions/earnings on Roth conversions (2nd 5 year rule - if in fact you've done any).

The twist here (as I understand it) is that contributions and conversions (amounts that were taxed already), would not be subject to taxes again. Penalties could be incurred if you were not 59.5 years of age, or the 5 year timer had not lapsed on affected conversions. Earnings (following the ordering rule) could also be subject to ordinary taxes.

I've read there are special considerations for penalties and taxes that are applicable in certain circumstances, but I don't want to bring them up here as this is confusing enough to me.

[pb4uski]

Well.... after considering the quantity and length of the last dozen or so posts in this thread, I have concluded that the thread title of "Quick Roth Conversion Tax?" is totally misleading.

[SecondCor521]

OK. @fritz, I can't tell if we're agreeing or if we're talking past each other. In either case, it seems to make sense for me to drop it, so I will. I appreciate the conversation.

[cat4ever]

Way ahead of you PB (which I'm sure is a first for me):

Quote:

Originally Posted by cat4ever I'm thinking the original subject of this thread is quite a misnomer, wish there were a way to change it.

Actually I think the terms "quick" and "Roth Conversion ?" should never be in the same sentence together.

[fritz]

I wanted to follow up on this thread with some additional information I've gotten on the (2) Roth 5 year rules. I was mistakenly looking at the (2) 5 year rules as uniquely applied to the two different areas of Roth IRA accounts - contributions and earnings, and conversions and their earnings.

The order is - 1st 5 year rule is used, and if not met, the 2nd 5 year rule (which only applies penalties to Roth conversion amounts - not taxes on earnings) is used.

The 1st Roth 5 year rule applies to contributions, conversions, and earnings. To withdraw funds (contributions, conversions, and earnings - in that ordering rule), without any contributions/conversions penalties and taxes on earnings - generally your Roth account has to be open for 5 years, and you must be older than 59.5 years of age.

There are other portions of the 1st 5 year rule specifically relating to exceptions that would allow you to withdraw funds without meeting the requirements, but don't want to confuse this with my original inquiry here. (see link below)

The 2nd Roth 5 year rule only comes into play on conversions, if you have not met the 1st 5 year rule's requirements (Roth account older than 5 years, and being older than 59.5). This would apply penalties on the conversion amounts, if the conversion had not lapsed its 5 year timer. Any conversions earnings come under the 1st 5 year rule (following the ordering rule).

Again, there are other portions of the 2nd 5 year rule that relate to specific exceptions for the rule, but don't want to confuse this with my original inquiry. (again, see link below)

Long story short - if you are older than 59.5 and at least (1) of your Roth accounts is older than 5 years, the 2nd 5 year rule does not apply. You will not be penalized or taxed on withdrawals from your Roth account. All contributions, conversions, and earnings (following the ordering rules) are considered qualified distributions.

I obtained this information from Mike Kitces. He also references his article from January 2014 for further clarification of the (2) 5 year Roth IRA Rules.

https://www.kitces.com/blog/understa...d-conversions/