Roth Conversion
I wish to convert my IRA to a Roth IRA as quickly as possible perhaps over a period of 3-5 years. The “5 Year Rule” is a bit confusing to me and would like to know what things to consider… how would this rule impact my planning?
It’s my understanding, the 5 year rule only applies to earnings not the conversion amount… true? If true, when you take withdrawals from your Roth who determines where the money is coming from- contributions vs earnings? And, if you do partial conversions over a few years things could get complicated. Maybe converting to Roth is not that great idea unless you can convert the entire IRA in the same tax year.
There are two 5 Roth 5 year holding periods, one for qualified earnings to be tax free, and the other for distributions of conversions to avoid the 10% penalty. Since your post related to conversions, I only addressed the conversion holding period.
If you take a distribution from your Roth before it is qualified (5 years and 59.5), the Roth ordering rules determines what portion you have distributed. Regular contributions come out first, then conversions starting with the oldest, and earnings come out last. But you cannot correctly report any non qualified Roth distributions without knowing the amount of regular and conversion contributions you have made (and not previously distributed). That means you must keep track of your contributions in order to be able to report an distributions you take before 59.5. You also must keep track of the year of your conversions so you will know when each conversion has been held 5 years and is therefore exempt from the penalty.
This tracking is much easier than it sounds, unless you take alot of distributions. It only takes 5 minutes each year to record your contributions and distributions on a sheet of paper or spreadsheet. Nonetheless, a lot of people fail to do this, and then are really stuck when they have a report a distribution. Not keeping track also means you will not know the tax consequence of a Roth distribution when you take it.
All tracking ends once your Roth is qualified, since all distributions are tax and penalty free thereafter, and Form 8606 is no longer required.
Permalink Submitted by Alan - IRA critic on Sun, 2021-04-25 18:11
The 5 year holding period for conversions results in a 10% penalty if you withdraw conversions before holding them 5 years. Conversions come out only after your regular contributions, and then oldest conversion first. The holding requirement stops at age 59.5 along with any other early distribution penalties. Of course, if you did not convert and took distributions from your TIRA instead, you would also pay the penalty up to 59.5.