Roth Conversion to Avoid 10% Penalty?
John converts his $50,000 TIRA to a Roth IRA and pays the federal income taxes when he is 30 years old. After the 5th year he withdraws the 50k (not the gain) and it is not included in gross income. Because the converted funds were used outside the 5 year period, they should not be subject to the 10% penalty. If there was gain withdrawn from the account than than it would be subject to the 10% penalty, but the basis created from the conversion wouldnt. This seems like an easy way to take your TIRA money under 59 1/2 without paying the 10% penalty [b]IF[/b] you can wait 5 years. Am I missing something here?
-J
Permalink Submitted by Alan Spross on Tue, 2009-05-26 22:55
You are correct. But most people who would tap their IRA early would need the money for a specific or urgent purpose so not too many people would have the planning discipline, the money, or the inclination to pay conversion taxes 5 years prior to actually getting their hands on the money, despite the opportunity to bank 5 years of earnings in their Roth.
Many needs to tap an IRA such as major medical costs, higher education, or SEPP distributions in the case of early retirement already have their own penalty exceptions. If you plan to start a business, your income in the first year might be so low that the marginal rate plus penalty might be less than the marginal rate alone in an earlier full earnings year. For certain combinations of circumstances however, it might work.