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Roth Conversion question

Technical topics regarding tax preparation.
#1
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I am reading that for each Traditional IRA you convert to a ROTH IRA, you must endure the 5-year waiting period before the earnings can be withdrawn tax-free. So every year you make a conversion, you have to start a new 5-year period for that new conversion.

And the fact that you have contributed to a "regular" ROTH IRA more than five years ago has no bearing on the new 5-year rule for a conversion.

So my client is 66. He converts a traditional IRA to a ROTH IRA. He treats the amount as taxable income. So if he withdraws ALL of the converted amount and earnings before he meets the 5-year rule, he will have to pay income tax and a 10% penalty on the withdrawn earnings?

Can anyone confirm that I am seeing this correctly? Thanks in advance.
 

#2
HowardS  
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Tax on the earnings, no penalty.
I suffer from depreciation.
 

#3
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Thank you. So I take it that since he is over 59, there would be no penalty on early withdrawal of earnings, just taxability, in case he withdraws before the 5-year timeline.

But do you think I am understanding correctly that each time a taxpayer converts traditional IRA funds into a ROTH, a new 5-year holding period begins? And if so, can he convert to the same ROTH each year, just has to maintain complex records as to the timing of each conversion? Or should he open a new converted ROTH account each time he converts?

The minutiae of these questions is the challenge of tax law. For me anyway. I too suffer from depreciation. Unfortunately it is accelerated depreciation.
 

#4
HowardS  
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New 5 year period for each conversion. I have a client who has been converting part of his significant IRA for the last 5 years. He has 10 separate Roth conversion accounts, his wife has 12. I think you should keep them separate.
I suffer from depreciation.
 

#5
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Thank you. This really helps.
 

#6
jon  
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Are not withdrawals from Roths always considered from non earnings first no matter when they happen??
 

#7
Doug M  
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https://www.law.cornell.edu/cfr/text/26/1.408A-6

This Roth Distribution Reg (Q&A format) is quite helpful. There are two 5 year Roth rules. One for contributions, another for conversions.

The 5 year rule for Roth contributions is really about the earnings. You can always withdraw your contributions in full at any time. If you want your earnings to be tax free, cannot take any earnings out for the first 5 years.

The second 5 year rule has to do with conversion funds that were put into a Roth. This is subject to a 5 year withdrawal rule.

If there are both contributions and conversions to the same IRA, contributions are deemed withdrawn first, then conversion funds, lastly earnings.
 

#8
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So if you're young and convert a traditional IRA to a ROTH, if you withdraw all of it before the 5-year rule is met (and before you're 59 1/2), then you pay a 10% penalty ON THE ENTIRE AMOUNT INCLUDING PRINCIPAL. At least, this is how it reads to me.

But if you are over 59 1/2, this does not apply. Correct?

Taxpayer is 65. He converts $35000 into a ROTH. When he is 67 he withdraws the $35000 plus $2000 of earnings. There are NO penalties. He merely has to pay tax on the $2000 of earnings. Correct?
 

#9
Doug M  
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When did he convert the $35,000? 2019?

Then, in 2021 he withdraws all of the conversion amount plus $2,000 in earnings?

Also, look at pub 590-B on page 28. There - qualified distributions discussed.

https://www.irs.gov/pub/irs-pdf/p590b.pdf

Distributions of conversion and certain rollover contributions within 5-year period.

If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount). A separate 5-year period applies to each conversion and rollover.
Last edited by Doug M on 14-Oct-2019 6:08pm, edited 1 time in total.
 

#10
HowardS  
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Correct. (responding to post #8)
I suffer from depreciation.
 

#11
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Thanks HowardS.

Doug M. I hope I understand this correctly. For example, a 50 year-old converts $50000 from a regular IRA into a ROTH, and recognizes $50000 of taxable income. 3 years later, he withdraws the $50000 plus $3000 of earnings. He is then taxed on the $3000 of earnings, and incurs a 10% penalty on the entire $53000.

The same scenario, but the taxpayer is 60 upon conversion, and withdraws the $53000 in 3 years. In this case he is only taxed on the $3000 of earnings. No penalties.

Hmm. I wonder if he was to make the conversion when 57, and then withdraw it when 60, after he exceeds 59 1/2, would he avoid penalties, and just have taxation on the earnings? I would have to assume that 59 1/2 is the deciding factor regarding the 10%. But not sure.
 

#12
Doug M  
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I agree with both of your scenarios.

As to the "straddle" age 59.5, I would be guessing, but the distribution was made after age 59.5, so yes.
 

#13
jon  
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Remember conversions, traditional to Roth, after RMDs are required do not qualify as RMDs.
 


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