Roth Conversion Withdrawals
I am assuming that Roth IRA withdrawals are first in-first out. For instance: if I want to take income from a Roth conversion it is tax free so long as I do not withdraw interest for the first five years, and I am over 59 1/2. In other words the five year rule only applies to interest earnings. Is this correct? Thanks.
Permalink Submitted by Alan Spross on Fri, 2011-04-01 16:50
Non qualified Roth distributions follow ordering rules that could be described as “FIFO by type of contribution”, not a pure FIFO. All regular contributions come out first no matter when contributed, but conversions are next and they do follow FIFO. However, for conversions the issue is only the early withdrawal penalty within 5 years since the conversion has already been taxed. And once you are over 59.5, the early withdrawal penalty no longer applies.
Earnings come out last, and are not assigned to any particular contribution. Earnings are the amount that the value of the IRA exceeds the contributed amounts. Once the Roth is qualified, earnings are also tax free, but to become qualified 5 years must pass from the year of your first Roth contribution, and you must also be 59.5 or disabled.
In your case, since you are over 59.5, you are free from any early withdrawal penalties. Your Roth is also fully qualified if your first contribution was prior to 2007 which would mean that you have met the 5 year holding period. If not, your earnings are still taxable until you do, but since they come out last, you probably would not be in a situation where they would be withdrawn prior to meeting the 5 year holding requirement.
Most confusion on these rules come from the fact that there are two separate and unrelated 5 year holding periods for Roth IRAs, one for conversion withdrawals under 5 years, and the other for the entire Roth to become qualified, ie ordinary income tax free.
Note: If you did a 2010 conversion and deferred the income, there is also an acceleration of conversion tax issue if you remove any of the conversion funds before 2012. This applies only to 2010 conversions and results in tax due date being moved up, not any additional tax.
Permalink Submitted by Brian Ditton on Sat, 2011-04-02 00:30
Alan,
Thanks very much for your reply. I think I’m clear on the issues, but could you give me more info with regards to what you said here.
Most confusion on these rules come from the fact that there are two separate and unrelated 5 year holding periods for Roth IRAs, one for conversion withdrawals under 5 years, and the other for the entire Roth to become qualified, ie ordinary income tax free.
Note: If you did a 2010 conversion and deferred the income, there is also an acceleration of conversion tax issue if you remove any of the conversion funds before 2012. This applies only to 2010 conversions and results in tax due date being moved up, not any additional tax.
What exactly are the two different and independent rules with regards to withdrawals form Roth conversions? Also, could you explain more about the acceleration of conversion tax issue? Thanks you very much.
Permalink Submitted by Alan Spross on Sat, 2011-04-02 02:45
The two different 5 year holding periods are:
1) For conversions only, they must be held 5 years to avoid an early withdrawal penalty; this ends at age 59.5
2) For regular taxation of earnings, a single 5 year holding requirement starting from the year of the first Roth contribution. This must be met for earnings to become tax free and taxpayer must also be 59.5.
The income acceleration ONLY affects those who did 2010 conversions and defer the income over 2 years. If the amounts converted in 2010 are taken out before 2012, the taxes are due in the year taken out rather than being deferred the full two years. You only need to be concerned with this if you:
a) converted in 2010 and deferred the income for 2 years.
b) and took out the conversion money prior to 2012
For example if you converted 50,000, 25,000 would be reported in 2011 and 2012, but if you took out 20,000 of that money in 2011, it would change to reporting to 45,000 in 2011 and 5,000 in 2012. In other words it moved the 20,000 you took out from 2012 to 2011.