Roth IRA Questions
I have 2 question regarding Roth IRA’s.
1. A $1,000,000 conversion to a Roth occurs at age 50.
The Roth IRA owner withdraws $100,000 a year for 8 years, from age 51 to age 58.
Although the amounts withdrawn, $800,000 in total, are not subject to income tax because they reflect a return of principal of the converted amount, is each $100,000 withdrawal subject to the non-deductible 10% penalty because each such withdrawal occurred prior to attainment of age 59 ½ ?
2. Same facts and question as # 1, above, [b]except[/b] the $1,000,000 was [b]not[/b] from the conversion of a Traditional IRA, it was from the cumulative contributions to a Roth IRA ($ 800,000) and interest growth thereon ($200,000)?
Permalink Submitted by Alan Spross on Tue, 2009-09-22 20:10
1) Each conversion must be held for 5 years to avoid the early withdrawal penalty, unless Roth owner reaches 59.5. In this case, each 100,000 distribution will be subject to penalty until 5 years has passed. The 5 years includes the calendar year of the conversion. Therefore, the last 4 annual distributions would NOT be subject to the penalty.
2) In this case, regular contributions can be withdrawn at any time with no tax or penalty. However, after 800,000 has been distributed under the “ordering rules” for Roth distributions, the earnings will amount to what is left. These earnings are subject to both tax and penalty because the Roth is not yet qualified. At 59.5, any further distributions would be tax and penalty free, as this Roth will become qualified at age 59.5 because it has also been held 5 years.
Permalink Submitted by David Hochstadt on Tue, 2009-09-22 21:13
By David (for Alan)
1) Are you 100% certain that all pre-age 59 ½ withdrawals from a converted Roth, not just those [b]after[/b] the first 5 years of pre-age 59 ½, do not incur the 10% penalty as to [b]all[/b] amounts withdrawn both before and after 5 years, but still prior to age 59 ½ ?
I think the rules changed to impose the 10% penalty on all pre-age 59 ½ withdrawals from converted IRA’s to dissuade pre-age 59 ½ IRA owners from converting and then withdrawing to avoid the 10% penalty.
2) Can you give me a specific statutory reference that no 10% penalty is incurred as to withdrawals after 5 years, but [b]before[/b] attainment of age 59 ½.
Permalink Submitted by Alan Spross on Tue, 2009-09-22 21:33
Certain. Here is a copy of the IRS Reg 1.408A(6) Q&A 5: see (b)
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Q–5. Will the additional tax under 72(t) apply to the amount of a distribution that is not a qualified distribution?
A–5. (a) The 10-percent additional tax under section 72(t) will apply (unless the distribution is excepted under section 72(t)) to any distribution from a Roth IRA includible in gross income.
(b) The 10-percent additional tax under section 72(t) also applies to a nonqualified distribution, even if it is not then includible in gross income, to the extent it is allocable to a conversion contribution, if the distribution is made within the 5-taxable-year period beginning with the first day of the individual’s taxable year in which the conversion contribution was made. The 5-taxable-year period ends on the last day of the individual’s fifth consecutive taxable year beginning with the taxable year described in the preceding sentence. For purposes of applying the tax, only the amount of the conversion contribution includible in gross income as a result of the conversion is taken into account. The exceptions under section 72(t) also apply to such a distribution.
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Congress apparently felt that 5 years was long enough to prevent anyone from converting simply to avoid the 10% penalty because they needed a withdrawal. Most people with cash needs are in no position to wait 5 years just to avoid a penalty. But remember, there are also other early withdrawal exceptions such as disability, first home purchase etc that will waive that penalty if taken before 5 years has elapsed.