Backdoor Roth 5 year rule

Submitted by Frank Petranka on Thu, 2020-12-17 15:17

A backdoor Roth uses a traditional IRA with after tax contributions. I have read on several reputable web sites the backdoor Roth would be subject to the conversion five year penalty rule. I received a Slott report today that describes a Roth conversion of Traditional IRA that contains only after tax dollars. The owner who is under 59 ½ withdraws the entire amount after three years. There are no earnings. The Slott report says there will be no penalty on the withdrawal: “there is never a penalty on converted after-tax dollars if withdrawn early”. I’m confused. Would you please explain this? Thanks.



Submitted by David Mertz on Thu, 2020-12-17 16:36

  • Section 72(t) of the tax code applies the early-distribution penalty only to taxable distributions.  Because the distribution from the traditional IRA was not taxable, even if the distribution had not been converted to Roth or rolled over it would not have been subject penalty.  Converting that nontaxable traditional IRA distribution to Roth does not change the fact that that that money is not subject to the early-distribution penalty when distributed.  This is made clear in CFR 1.408A-6 Q&A-5(b):  https://www.law.cornell.edu/cfr/text/26/1.408A-6
  • The example in the Slott Report talks about the case where the entire Roth conversion was nontaxable.  If the particular Roth conversion instead consists of both taxable and nontaxable amounts, the Roth IRA distribution ordering rules dictate that the taxable portion comes out first, subject to penalty if the 5-year period has not been completed and the participant is under age 59½, before the nontaxable portion of the conversion comes out penalty-free.

Submitted by Peter Karakondis on Mon, 2020-12-21 17:47

posted in error under wrong topic

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