Roth IRA Conversion Clarifcation

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milford

Recycles dryer sheets
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Jul 25, 2020
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Hi all,

Can someone help me clarify the roth ira 5 year conversion rule and withdraws before turning 59.5. So for example, I do a 5k conversion this year and I use that money to buy vti. Fast forward it’s 2026 i’m 50 and I want to take that money out for spending and sell vti which has gone up to 6k… Can I take the full amount of 6k out tax free or can I only take 5k out tax free and if I wanted to take the 6k out i would have to pay taxes on the 1k? Am I understanding the this correctly?
 
This is my understanding. You can take out the $5K tax and penalty free after 5 years. Taking out the earnings before 59.5 would be taxed and there is a 10% penalty for early withdrawal.


UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes
 
Last edited:
milford said:
Hi all,

Can someone help me clarify the roth ira 5 year conversion rule and withdraws before turning 59.5. So for example, I do a 5k conversion this year and I use that money to buy vti. Fast forward it’s 2026 i’m 50 and I want to take that money out for spending and sell vti which has gone up to 6k… Can I take the full amount of 6k out tax free or can I only take 5k out tax free and if I wanted to take the 6k out i would have to pay taxes on the 1k? Am I understanding the this correctly?
Click to expand...

The IRS tracks dollars contributed and converted, not investments and anything else inside the Roth IRA.

So if you do a $5K conversion this year, that's the end of the conversation. It doesn't matter what you buy, and it doesn't matter the result (almost always).

When you take money out, you don't get to choose which dollars you take out. Your first dollars withdrawn will be deemed to be your Roth contributions.

After you have withdrawn your Roth contributions, then you will be deemed to be withdrawing converted dollars, from oldest to most recent.

After you withdraw all of your conversions, you will be deemed to be withdrawing your earnings.

...

So in the case you describe, your withdrawal would actually probably be earlier Roth contributions (if you made any). If you hadn't made any or had withdrawn them all before 2026, then the first $5K would be from your 2021 conversion (unless you had done any conversions last year or in prior years). Then the next $1K would be earnings, which since you are younger than 59.5 would be I believe both taxed and 10% penaltied, as the table above outlined.
 
Thanks for the replies… and does anyone knows if the brokerages help you keep track of your contributions/conversions vs. earnings/gains? I just took a look at my 5498 form for 2020 and there is no breakdown of how much money is from contributions vs. earnings or realized captial gains. Does one have to keep track of this manually by themselves?
 
milford said:
Thanks for the replies… and does anyone knows if the brokerages help you keep track of your contributions/conversions vs. earnings/gains? I just took a look at my 5498 form for 2020 and there is no breakdown of how much money is from contributions vs. earnings or realized captial gains. Does one have to keep track of this manually by themselves?
Click to expand...

The info is on your 5498s, but you need to keep them all. The 2020 form will only show deposits and withdrawals for last year. You would need them all to build a complete history and calculate your basis. Once you have that, the earnings are just everything above the basis. Your brokerage will keep seven years worth of 5498s online and they might be able to help you get the older ones as well. Conversions are also on your tax returns if you've saved those.

I personally don't save all the 5498s, but I do keep a spreadsheet that has the following colums for each of our Roth IRAs going back to their opening dates:
- Year
- After Tax Contribution
- Roth Conversion Amount
- EOY Account Value
- EOY Basis

I add a new line every year when I do our taxes, and I have similar sheets for the tIRAs and HSAs. I don't think we'll ever be close to withdrawing any funds the IRS would ask questions about, but if they do ask, I figure that having contemporaneous records should be sufficient to explain what we've done.
 
But can I safely burn all those 5498s and tax returns after I turn 59-1/2 as long as my Roth is more than 5 years old?
 
pb4uski said:
But can I safely burn all those 5498s and tax returns after I turn 59-1/2 as long as my Roth is more than 5 years old?
Click to expand...

I would say three years after, yes. In theory they could audit your tax return from your 58th year in the year you are 60.

There also may be some rare edge cases (@cathy63 will probably know) where your kids might need to know that information, but I don't think it's needed in the general common situation that you probably have.
 
pb4uski said:
But can I safely burn all those 5498s and tax returns after I turn 59-1/2 as long as my Roth is more than 5 years old?
Click to expand...

SecondCor521 said:
I would say three years after, yes. In theory they could audit your tax return from your 58th year in the year you are 60.

There also may be some rare edge cases (@cathy63 will probably know) where your kids might need to know that information, but I don't think it's needed in the general common situation that you probably have.
Click to expand...

I agree it's generally o.k. to stop keeping records once you are past age 59 1/2, assuming you've had a Roth IRA at least 5 yrs by then and wouldn't be subject to any penalties for any type of withdrawal. The IRS gets 5498 data from your broker, so even if you don't keep it throughout the audit period, they should already have it, and as I said before you can always get the past 7 years of docs from your broker. 5498s are only generated in years when there is activity. You won't have them for years when the account just sat there with no contributions, conversions, withdrawals.

The only thing that might affect your kids (assuming you mean as beneficiaries of your account after you die) is that the 5 yr rule still applies. If you inherit a Roth IRA that has been open for less than 5 years and take money out of it, you owe ordinary income tax on whatever portion of the withdrawal is earnings. The 10% penalty is waived if the original account owner died. If you don't know how old the account is or how much of it is earnings, you can avoid the issue by leaving it alone for 5 years. So it might be helpful to your kids if you leave documentation showing that you've had a Roth IRA for more than 5 years. But then again, as long as you haven't moved it recently, the broker should also know that and communicate it to them as part of setting up their Inherited Roth IRA accounts.
 
cathy63 said:
The only thing that might affect your kids (assuming you mean as beneficiaries of your account after you die) is that the 5 yr rule still applies. If you inherit a Roth IRA that has been open for less than 5 years and take money out of it, you owe ordinary income tax on whatever portion of the withdrawal is earnings. The 10% penalty is waived if the original account owner died. If you don't know how old the account is or how much of it is earnings, you can avoid the issue by leaving it alone for 5 years. So it might be helpful to your kids if you leave documentation showing that you've had a Roth IRA for more than 5 years. But then again, as long as you haven't moved it recently, the broker should also know that and communicate it to them as part of setting up their Inherited Roth IRA accounts.
Click to expand...

I knew you would know! :) That's the information I was referring to earlier. Thanks!!
 
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