Can I Convert Funds From an IRA to a Roth IRA Before Age 59 1/2?

By Beverly DeVeny and Jeffrey Levine
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It’s time for another edition of The Slott Report Mailbag, where we answer a parent’s question on whether her son’s Roth IRA contributions were done within the rules, assess whether an IRA account can be converted to a Roth IRA before age 59 ½ and examine an employee’s pro-rata complexities with moving after-tax 401(k) funds to both a traditional and Roth IRA. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

I opened a Roth IRA for my son and reported the contribution on a W-2. This was not a business, but was a payment for actual chores that he did for me. I did this for three years – 2009 through 2011. We feel the work was legitimate and actually marked the dates and times on a calendar.

I now read that this is not wages and should not be done. It is hard for me to understand why, but what should I tell him to do with the account as he is now 19. I don’t want him to be in trouble with IRS later?

Answer:
While there are certainly scenarios where a parent can pay a child, either as an employee or as an independent contractor, for services performed, taking care of household chores is not one of those situations. There is longstanding history of this, with cases going back into the 1960s treating payments for chores and the like as part of “parental training and discipline.” Thus, in your particular situation, your son had no real income from which to make Roth IRA contributions for 2009-2011. As a result, the amounts contributed are all “excess contributions,” subject to a 6% penalty for each year they remain in the account without being corrected. If your son has never had “real” earnings, these contributions still represent excess amounts and must be distributed to avoid further penalties. For each year there is a penalty to report – which could be 2009-2015 – he’ll need to file Form 5329 to report the excess contribution penalty. This is not something the IRS has the authority to waive, and if nothing is done to correct the issue, the problem will only get worse in future years.

2.

Can IRA accounts be converted to Roth IRAs prior to age 59 ½?

Answer:
An IRA account can be converted to a Roth IRA by the account owner at any age. If you are under age 59 ½ at the time of the conversion, the 10% early distribution penalty does not apply to the amount converted. Speaking of the 10% early distribution penalty, here’s 10 things to know about how it impacts IRA planning.

3.

I am 61 years old and I have made after-tax contributions to my 401(k), which allows in-service withdrawals. If I want to transfer the entire after-tax dollars to a Roth IRA and its earnings to a Traditional IRA, does the pro-rata rule apply to this distribution? I will still have a significant amount of pre-tax contributions remaining in the 401(k).  

Answer:
Any distribution you take from an employer plan will be treated as a pro-rata distribution. However, a distribution can be split and go to more than one destination. The way this works is that you designate any pre-tax amounts to go directly to an IRA account. You then designate after-tax amounts to go to a Roth IRA. Many employers will do only one direct transfer so you end up with the after-tax amount being sent directly to you. You then have 60 days from the date you receive the funds to complete a rollover by depositing the funds into a Roth IRA. You are not limited to this scenario. You can split up your distribution any way you want; for example, send all amounts to an IRA or send some of your pre-tax amounts to a Roth IRA.