Roth Conversion Withdrawal Sequence

[Austin704]

I've looked at many posts on the forum trying to find answers to my questions but either I can't find it or I may have missed it... Or maybe I just don't know what I'm doing!

I'm 55 years old and in the second of six years (2020-2025) of Roth conversions from a tIRA that is entirely taxable (i.e. all pre-tax contributions). All these conversions are going from a single tIRA to a single Roth IRA, so each year's conversion amounts are added to the previous years' amounts.

I understand that the holding period for each year's conversion is 5 tax years and that each conversion tax year has its own 5-year holding period. Once the 5-year holding period is met on a single conversion tax year and I'm over age 59.5 all distributions are qualified, including earnings on that conversion. Sequence of withdrawals is contributions first, then conversions, earnings last.

Question 1: Does the sequence of withdrawals apply "vertically" within each conversion tax year or "horizontally" across multiple conversion years? Example, in 2026 conversion years 2020 and 2021 will have met the 5-year holding period but 2022-25 will not. As I withdraw funds, do all the conversion amounts from 20-21 come out first and then earnings from those years, or does 2020's conversion amount then earnings come out first, followed by 2021's?

Question 2: Does the answer to question 1 really matter? As long as I don't exceed the total of the conversion + earnings for years 20-21 I won't be taxed right?

Question 3: Using the above example, six years after starting conversions how can I possibly know how much earnings are associated with conversion years 20-21? It's easy enough to track conversion amounts, but earnings by conversion year across multiple years? Makes my head hurt.

Question 4: Am I thinking about this the right way?

Thanks for your help!

 

[SecondCor521]

Q1 - The IRS always requires you to treat withdrawals as contributions first, then conversions second from oldest to newest, then earnings last. So after you've withdrawn any contributions to your Roth, the next thing would be the 2020 conversion amount, then the 2021 conversion amount, then the 2022 conversion amount, ... then earnings, which is essentially defined as whatever amounts were not contributed or converted.

Q2 - As long as your withdrawals don't exceed the total of your contributions plus all of your conversion amounts prior to five tax years ago then you won't be penalized. You will have been taxed on the conversion amounts at the time of the conversions, of course.

Q4 - I'm answering them out of order. No, you're not. See the answer to Q3 below.

Q3 - You don't have to, and neither does the IRS. The IRS never associates earnings with conversions and they don't have to. The IRS only deals in *dollar amounts* and *conversion years*. If you convert $20,000 in 2020, then in 2025 you can withdraw $20,000 from your Roth without taxes or penalties. Regardless of whatever happened inside your Roth in the intervening timeframe. There is never any connection between the dollars and the investments and investment activity inside the Roth.

Also, this:

"Once the 5-year holding period is met on a single conversion tax year and I'm over age 59.5 all distributions are qualified, including earnings on that conversion."

is not right. If you meet a 5 year holding period for a conversion, the distribution is qualified even if you're under 59.5.

After 59.5, all distributions are qualified as long as you've had the Roth open 5 years or more. Which it sounds like clearly you will have met. So if you do a Roth conversion at age 58, that conversion can be distributed without tax or penalty at age 59.5, even though you haven't met the 5 year conversion period.

The rules are complicated, confusing, and frequently mischaracterized. I think I've got the above mostly right; if not someone will come along and correct me

 

[Dash man]

I've looked at many posts on the forum trying to find answers to my questions but either I can't find it or I may have missed it... Or maybe I just don't know what I'm doing!

I'm 55 years old and in the second of six years (2020-2025) of Roth conversions from a tIRA that is entirely taxable (i.e. all pre-tax contributions). All these conversions are going from a single tIRA to a single Roth IRA, so each year's conversion amounts are added to the previous years' amounts.

I understand that the holding period for each year's conversion is 5 tax years and that each conversion tax year has its own 5-year holding period. Once the 5-year holding period is met on a single conversion tax year and I'm over age 59.5 all distributions are qualified, including earnings on that conversion. Sequence of withdrawals is contributions first, then conversions, earnings last.

Question 1: Does the sequence of withdrawals apply "vertically" within each conversion tax year or "horizontally" across multiple conversion years? Example, in 2026 conversion years 2020 and 2021 will have met the 5-year holding period but 2022-25 will not. As I withdraw funds, do all the conversion amounts from 20-21 come out first and then earnings from those years, or does 2020's conversion amount then earnings come out first, followed by 2021's?

Question 2: Does the answer to question 1 really matter? As long as I don't exceed the total of the conversion + earnings for years 20-21 I won't be taxed right?

Question 3: Using the above example, six years after starting conversions how can I possibly know how much earnings are associated with conversion years 20-21? It's easy enough to track conversion amounts, but earnings by conversion year across multiple years? Makes my head hurt.

Question 4: Am I thinking about this the right way?

Thanks for your help!

If you plan to be 59 1/2 before taking distributions and you opened your Roth more than five years ago, you can take out whatever you want.
You appear to be overthinking this unless you expect to take a large distribution before you turn 59 1/2.

 

[Austin704]

Awesome response SecondCor521!

This really helps clarify some of the murkiness. Sounds like the focus should be on the timing and amounts of contributions and conversions and not on earnings. This is much easier to track. As long as I don't withdraw amounts in excess of contributions and conversions held at least 5 years, I won't be penalized, regardless of my age.

And once I'm past age 59.5 there are no taxes on earnings as long as at least 5 tax years have passed since first opening a Roth. I assume this 5-year clock started when I made the first conversion in January 2020.

These questions are mostly academic because I have no intention of withdrawing Roth $$ that is growing tax free any earlier than necessary. I would draw down taxable or any remaining tIRA $$ and then Roth last. But I like to understand what I'm getting myself into...

 

[Austin704]

Thanks Dash Man. I don't plan to take any distributions prior to age 59.5 and probably far longer than that.

 

[SecondCor521]

Awesome response SecondCor521!

This really helps clarify some of the murkiness. Sounds like the focus should be on the timing and amounts of contributions and conversions and not on earnings. This is much easier to track. As long as I don't withdraw amounts in excess of contributions and conversions held at least 5 years, I won't be penalized, regardless of my age.

And once I'm past age 59.5 there are no taxes on earnings as long as at least 5 tax years have passed since first opening a Roth. I assume this 5-year clock started when I made the first conversion in January 2020.

These questions are mostly academic because I have no intention of withdrawing Roth $$ that is growing tax free any earlier than necessary. I would draw down taxable or any remaining tIRA $$ and then Roth last. But I like to understand what I'm getting myself into...

Your first two paragraphs above are correct.

The only reason I track my conversions is in case I need to supplement my miscellaneous income plus my taxable account before 59.5. Then I could pull from the Roth without any additional penalty, whereas the traditional IRA would either have a penalty or I'd have to start a SEPP.

I'm 51 almost 52, and it looks like I won't need the Roth conversion ladder (or SEPPs) after all.

 

[teej1985]

I used to have a token Roth IRA at USAA to get an insurance discount. I didn't bother rolling over, they sent me a check. It was a distribution. By the time I start withdrawing from Roth again, I don't know how the IRS would ever know about my tiny distribution from decades earlier.

 

[PoorOldCountryBoy]

Does anyone know if a Roth IRA rollover can disqualify someone from stimulus payments due to the higher taxable income? Just curious about that angle.

 

[TheWizard]

Does anyone know if a Roth IRA rollover can disqualify someone from stimulus payments due to the higher taxable income? Just curious about that angle.

A rollover of an existing Roth IRA from one custodian to another is not a taxable event and will not affect your AGI.

But a Roth Conversion (from a traditional IRA to a Roth IRA) increases your AGI by the amount converted...

 

[pb4uski]

Does anyone know if a Roth IRA rollover can disqualify someone from stimulus payments due to the higher taxable income? Just curious about that angle.

If you're talking about a rollover (moving money from one Roth to another or from a Roth 401k to a Roth IRA), then no... because a rollover isn't a taxable event.

OTOH, if you're talking about a Roth conversion, then yes, it could.

 

[teej1985]

Does anyone know if a Roth IRA rollover can disqualify someone from stimulus payments due to the higher taxable income? Just curious about that angle.

If it takes your AGI above the phase out, of course.