"Free" Roller to Roth IRA?

[Gearhead Jim]

Many of us in the airline industry had pensions "terminated"; we still get something but not as much as originally planned.
My union negotiated a deal whereby when the airline came out of Ch 11, we received stock and notes, converted to cash, to partially compensate for the reduced pension. I received my payments in 2006 and 2007. There was no way to shelter any of that money, it all got taxed as ordinary income (ouch!).
A recent change in the law allows us to take an amount equal to the payments we received, and place it in a Roth IRA as if it were a rollover. We would not get any break on the taxes already paid, and would not be re-filing our previous years returns, just sheltering the future gains from tax. We can not shift money from a regular IRA into the Roth, unless we pay tax on the amount shifted.

So, I can do it. But is it a good idea? My understanding is that the money is required to stay in the Roth for 5 years, and that any money taken out before then is considered a return of gains (pay the tax) and not a return of the already-taxed principal.
I'm thinking that if I don't need the money for those 5 years, this is a worthwhile deal. If I will need to take money out of my regular IRA instead of using the money that i would convert to Roth, it's a marginally useful deal once we get beyond the 5 years.

Suggestions and opinions?

 

[OAG]

IMO if you will be leaving the money there for at least the required 5 years it would be a win win since you already have paid the tax on the amount you would be moving to the ROTH. The second "win" is that you can almost bet tax rates will be going up and when coupled with the increase in income due to SS the bet gets even better odds.

 

[samclem]

Other than the loss of flexibility (for the next 5 years), I don't see a down side. IIRC, with a normal Roth, you can also remove your contributions (not your gains) at any time and not pay any penalties. Regardless, if you move these funds to a Roth you'd never pay taxes on the gains, so that sounds all to the good.

 

[Alan]

My understanding is that the money is required to stay in the Roth for 5 years, and that any money taken out before then is considered a return of gains (pay the tax) and not a return of the already-taxed principal.

If this is the case then there are no down sides. If you have your money invested now in income generating investments such as CD's etc then you are certain to pay taxes on the income. In this special arrangement you will only pay tax on that income if you have to withdraw it inside 5 years, so it is win-win. (If you keep it for 5 years then you'll never have to pay taxes on it).

 

[Gearhead Jim]

...
IIRC, with a normal Roth, you can also remove your contributions (not your gains) at any time and not pay any penalties.
...

Someone told me the IRS considers that you always withdraw the gains first, later withdrawls are considered to be principal. IF that is correct, any withdrawals in the first 5 years would incur tax. Anyone know if this is correct?

 

[samclem]

Someone told me the IRS considers that you always withdraw the gains first, later withdrawls are considered to be principal. IF that is correct, any withdrawals in the first 5 years would incur tax. Anyone know if this is correct?

According to this web site, tax-free withdrawals can be made by specifying to your custodian that the withdrawals are to be from your contributed amount. I have no personal knowledge or experience with the issue.

 

[LOL!]

Since the money you would put in is coming from a taxable account, you surely realize that any gains would be taxed if you used the money. That goes for whether the money is not in the Roth IRA or is in the Roth IRA and used in the early years.

So if you have the money to put it, it certainly seems to be a no-brainer to put the money into the Roth.

 

[REWahoo]

According to this web site, tax-free withdrawals can be made by specifying to your custodian that the withdrawals are to be from your contributed amount.

Yep. Here is another well-respected source: Tax-Free Distributions from Roth IRAs

 

[Gearhead Jim]

Since the money you would put in is coming from a taxable account, you surely realize that any gains would be taxed if you used the money. That goes for whether the money is not in the Roth IRA or is in the Roth IRA and used in the early years.

So if you have the money to put it, it certainly seems to be a no-brainer to put the money into the Roth.

Perhaps I'm misunderstanding you. The money being put into this Roth would be coming, in my case, from an ordinary CD and the tax has already been paid on the principal (when i first received it), and the up-til-now earnings (taxed each year). I don't believe that the principal in the Roth would ever be taxed, and future gains would not be taxed if I left them in for 5 years. Or did you mean something different?

 

[LOL!]

I meant something different. I was talking about the GAINS. As you wrote, your gains are now taxed (you paid taxes on the CD interest). If you put the money in the Roth, the gains won't be taxed unless you somehow manage to take the gains out before 5 years. In either case your principal is not taxed. Since there is really no downside to the Roth even if you needed to withdraw the money early, it's a no brainer.

 

[Gearhead Jim]

Got it, thanks!