Roth conversion 5-year rule?

[engineernerd]

I now think VanWinkle, Out-to-Lunch, SecondCor521, and FREE866 are right.

It looks to me like the separate 5-year rule for conversions only applies if you are not yet 59 1/2 and/or have not had a Roth IRA (with funds in it) for at least 5 years. Well, 5 years according to the IRS's definition.

...and TheWizard! Sorry I didn't notice your contribution.

 

[Out-to-Lunch]

It does seem strange that Fidelity, Schwab, and Vanguard all say that each Roth conversion has its own 5 year clock even after 59 1/2.

But they DON'T say that. There is lots to wade through, but Fido, VG, and Schwab all concur with the no-tax-on-earnings-post-59.5 position, as long as any Roth has been open 5 years.. (I added some emphases.)

Vanguard: IRA withdrawal rules explained | Vanguard

• Withdrawals after age 59½: Once you reach age 59½, you can withdraw both contributions and earnings from a Roth IRA tax- and penalty-free, provided the account has been open for at least 5 years.
• The 5-year rule: Earnings withdrawn before you've held the account for 5 years will be taxed and, if you're under 59½, subject to a 10% penalty, unless an exception applies. The 5-year period begins on January 1 of the tax year in which you made your first Roth IRA contribution. For those under 59½, each conversion from a traditional IRA has its own separate 5-year period before earnings can be withdrawn tax-free.

Listen to Chuck. Schwab: Roth conversion 5-year rule?

Roth conversion five-year rule​

This is a completely separate five-year rule covering Roth IRA conversions from a traditional IRA or 401(k). Importantly, each Roth conversion has its own five-year holding period, which starts on January 1 of the year in which the conversion occurs.

After age 59½, you can withdraw converted funds without a 10% penalty. But remember, the five-year contribution rule (mentioned above) still applies—if that rule hasn't been met, taxes may apply for the earnings portion of the withdrawal.

(Of course, that means if the 5-year contribution rule HAS been met, then taxes on earnings do NOT apply.)

And finally Fidelity: What is the Roth IRA 5-year rule and how does it work? | Fidelity

(To be fair, Fidelity is not crystal-clear on what "5-year rule" they are referring to in the following passage.)

Once the 5-year rule has been met and the account owner is age 59½ or older, among other exceptions, they may make what's known as a qualified distribution of earnings exempt from both taxes and penalties.1"

 

[COcheesehead]

But they DON'T say that. There is lots to wade through, but Fido, VG, and Schwab all concur with the no-tax-on-earnings-post-59.5 position, as long as any Roth has been open 5 years.. (I added some emphases.)

Vanguard: IRA withdrawal rules explained | Vanguard




Listen to Chuck. Schwab: Roth conversion 5-year rule?



(Of course, that means if the 5-year contribution rule HAS been met, then taxes on earnings do NOT apply.)

And finally Fidelity: What is the Roth IRA 5-year rule and how does it work? | Fidelity

(To be fair, Fidelity is not crystal-clear on what "5-year rule" they are referring to in the following passage.)

Not sure about this. I posted evidence to the contrary. I think it’s still unclear.

 

[wannabefire]

Fascinating discussion and reminds me just how complicated our tax code is

 

[NW-Bound]

At the risk of throwing more confusion into this thread, I can't help add something.

There's 1) the 5-year rule for penalty-free withdrawal of conversion money.
And 2) there's the 5-year rule for withdrawal of earnings without penalty.

The reason for the 1st rule was this. We all know we cannot withdraw from IRA prior to 59-1/2 without incurring a penalty in addition to an income tax. Yet, we can do Roth conversion with tax and without penalty at any age. So, what prevents a young guy who wants to withdraw from IRA without penalty by doing a Roth conversion first, then withdraw from the Roth? Nothing. He just has to pay the same penalty as if he withdrew directly from the IRA. If he waits 5 years, then the penalty is waived.

And that's why each conversion comes with its own 5-year delay. And of course this does not apply for people above 59-1/2, because they already can withdraw directly from their IRA without penalty.

 

[Taco]

I wonder what any of them say about the flowchart in the IRS instructions which is shown and linked to earlier in this thread. It seems quite straightforward to me. I would have no qualms about withdrawing from my Roth after 59 1/2 and 5 years since my first Roth contribution.

If you read thru the text from the beginning of the Roth IRA section up to that flowchart, it never mentions conversions. Just contributions.

And a little below the flowchart, is this:

“The 5-year period used for determining whether the 10% additional tax on early distributions applies to a distribution from a conversion or rollover contribution, is separately determined for each conversion and rollover, and isn't necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution. See What Are Qualified Distributions, earlier.”

Those last 2 sentences seem to say that “conversions do not use the same as the rules in the What Are Qualified Distributions” flowchart.

It also pretty clearly states that each conversion has a separate 5 year period, which “isn’t necessarily the same” rules as specified in the flowchart.

 

[Taco]

Note that while I think it’s clear that the flowchart does not work for conversions, there’s also an exceptions section, which might? be saying it is all moot if you’re 59.5

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

• You have reached age 59½.

 

[TheWizard]

It's important to note that one of the five year rules is based on when you first open and fund your first Roth IRA.
That funding can be done with either a contribution or a conversion.

Sometimes you will encounter sloppy writing on that one...

 

[Out-to-Lunch]

isn't necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution.

As the example that is given just below indicates, that means that conversions are backdated to Jan. 1 of the calendar year that they are made in, while contributions are backdated to the tax year that they count towards. And these are "not necessarily the same."

 

[TheWizard]

Note that while I think it’s clear that the flowchart does not work for conversions, there’s also an exceptions section, which might? be saying it is all moot if you’re 59.5

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

• You have reached age 59½.

The chart in #14 is correct.
Use that ...

 

[SecondCor521]

If you read thru the text from the beginning of the Roth IRA section up to that flowchart, it never mentions conversions. Just contributions.

A conversion is a form of contribution. In fact, the section you quote below uses the phrase "a conversion or rollover contribution".

The flowchart is talking about all distributions (see it's title). Whether any distribution is qualified is in part determined by when the first contribution was made. That is why the flowchart and the text immediately before it talks about contributions: contributions are what starts the clock for qualified distributions.

And a little below the flowchart, is this:

“The 5-year period used for determining whether the 10% additional tax on early distributions applies to a distribution from a conversion or rollover contribution, is separately determined for each conversion and rollover, and isn't necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution. See What Are Qualified Distributions, earlier.”

Those last 2 sentences seem to say that “conversions do not use the same as the rules in the What Are Qualified Distributions” flowchart.

It also pretty clearly states that each conversion has a separate 5 year period, which “isn’t necessarily the same” rules as specified in the flowchart.

Yes, the last two sentences you quote point out that there are indeed two different five year rules, as others have repeatedly pointed out.

The first five year rule relates to early distributions (i.e., before 59.5) of converted amounts. This first five year rule is irrelevant in certain cases because of the second five year rule related to qualified distributions, which is the path in the flowchart I've been repeatedly pointing to.

In essence, the second five year rule nullifies the first five year rule if over 59.5 and the first Roth contribution (whether a regular contribution or a conversion contribution) is more than five years ago.

 

[NW-Bound]

I am elaborating a bit more on my post #55 above.

Bob, who is 50, wants to withdraw money from his IRA without paying 10% penalty. He thinks he can "cheat" by doing a Roth conversion, pays just the tax, then withdraws from Roth without penalty. Nope, not so fast. He still has to pay the 10% penalty unless he waits.

The 5-year timer rule on each conversion prevents that. Still, waiting 5 years to save 10% is not a bad deal. And that's why each conversion comes with its own 5-year delay for the penalty waiver.

Roth contributions are different because they do not come from IRA.

Now, Steve, who is 60, can already withdraw from IRA without penalty. There's no need to use Roth penalty to keep Steve from cheating, because he does not need to cheat.

 

[stepford]

I'm over 60, have been doing Roth conversions for 5+ years and will continue doing them for the foreseeable future. We all agree that I can pull out my contributions whenever I want without tax or penalty.

What about the earnings?

Since money is fungible how do I determine what earnings are within which 5 year window - if I am indeed starting a new 5 year window with each conversion? My take was that at this point I could pull out any and all earnings tax free, but if I am incorrect and must identify which earnings are which, please let me know.

 

[SecondCor521]

I'm over 60, have been doing Roth conversions for 5+ years and will continue doing them for the foreseeable future. We all agree that I can pull out my contributions whenever I want without tax or penalty.

What about the earnings?

Your entire Roth balance, including your earnings, can be distributed tax and penalty free. See my link and the flowchart cited earlier.

Since money is fungible how do I determine what earnings are within which 5 year window - if I am indeed starting a new 5 year window with each conversion?

It's irrelevant for you (see above and below), but for sake of completeness, the IRS does not allocate earnings to their associated conversion amounts.

The IRS has you tally up how many dollars you have contributed and how many dollars you have converted. Any dollars in your Roth IRA balance beyond that are your earnings dollars.

The key insight is that the IRS views your Roth IRA as a black box with dollars going in and dollars coming out. They don't care about what goes on inside the account.

My take was that at this point I could pull out any and all earnings tax free, but if I am incorrect and must identify which earnings are which, please let me know.

You're correct, it's irrelevant in your situation.

 

[orbops]

I'm going to be calling the Taxpayer Advocate Service in the next month or two to deal with some trustee issues. I'll also bring up this question of the 2nd 5 year rule and reference the flow chart Fig 2-1 in Pub 590-B and see what they say.

 

[SevenUp]

A conversion is a form of contribution.

Exactly. The amount that you withdraw and timely contribute (convert) to the Roth IRA is called a conversion contribution.

 

[SevenUp]

I'm going to be calling the Taxpayer Advocate Service in the next month or two to deal with some trustee issues. I'll also bring up this question of the 2nd 5 year rule and reference the flow chart Fig 2-1 in Pub 590-B and see what they say.

If they say anything other than,"All Roth IRA distributions are tax- and penalty-free after age 59.5 when money went into a Roth IRA at least five tax years ago" (or words to that effect), I'll think poorly of the TAS.

 

[orbops]

If they say anything other than,"All Roth IRA distributions are tax- and penalty-free after age 59.5 when money went into a Roth IRA at least five tax years ago" (or words to that effect), I'll think poorly of the TAS.

I called the IRS Taxpayer Advocate line earlier this week and that was a dead end after like 30 minutes of discussion. They transferred me to the customer service line - unfortunately the wait time was 30-60 minutes and I didn't feel like waiting. I'll try calling them again next week and see what they say.

 

[Al18]

I would call your broker who is doing the RothIRA conversions for accurate info.

 

[SevenUp]

I would call your broker who is doing the RothIRA conversions for accurate info.

Better yet, rely on the IRS documents referenced throughout this thread that confirm after age 59.5 and having put money into the oldest Roth IRA at least 5 years ago, all distributions are tax- and penalty-free.

Relying on a random broker's customer service person is up (or down) there with relying on Artificial Intelligence for accurate answers.

 

[Al18]

Fidelity has specialized FA who specialize in RothIRA conversions.

 

[CautaServans]

Each rollover starts its own 5 year clock for tax on the earnings.

Thanks, helpful!

 

[FREE866]

Thanks, helpful!

if you're over 59.5 that is incorrect

 

[CautaServans]

if you're over 59.5 that is incorrect

Good to know. I'm not there yet, but I am close enough!

 

[SecondCor521]

Fidelity has specialized FA who specialize in RothIRA conversions.

They probably are specialized in executing Roth IRA conversions, but they are probably not specialized in tax advice on those Roth IRA conversions.