5 year rule

Submitted by Robert Wright on Wed, 2009-11-04 17:42

I need clarification on the 5 year rule for 401k rollovers to Roth IRAs

1. Does each rollover Roth IRA (from a Roth 401k and/or regular 401k) have its own 5 year “clock” separate from the 5 year clock for a contributory Roth IRA?

i.e. if, I rolled over the 401k from two previous employers, Employer A and Employer B, to two separate Roth IRA’s, say Roth IRA “A” and Roth IRA “B”, would each of these rollover Roth IRAs have their own 5 year clock?

2. Is the clock for these two rollover Roth IRAs separate from the clock for my contributory Roth IRA, say, Roth IRA “C”?



Submitted by Alan Spross on Wed, 2009-11-04 18:44

1. A Roth 401k rollover is not a conversion since the funds are already in a Roth option. If the Roth 401k was not qualified at the time of rollover, the 5 year clock for earnings qualification is that of the Roth IRA. There is no 5 year conversion holding period because this is not a conversion. However, a direct Roth conversion from a pre tax 401k account IS a conversion and the 5 year holding period does apply for purposes of withdrawing those conversion funds without incurring the 10% early withdrawal penalty.

2. There are separate 5 year clocks for each conversion with respect to early withdrawal. If two different pre tax 401k accounts are converted in the same year, those conversions both have the same 5 year holding requirement. Reaching 59.5 wipes out the holding requirement. But for the Roth IRA earnings to become qualified, THAT 5 year holding period clock starts with the first Roth IRA of any type. There is only one clock for here regardless of how many Roth IRA accounts exist.



Submitted by Robert Wright on Wed, 2009-11-04 20:31

Alan,
Forgive me, I’m a little slow on the up-take.
Can you explain what you mean by: “Reaching 59.5 wipes out the holding requirement”
Thanks.



Submitted by Alan Spross on Wed, 2009-11-04 20:59

The 5 year holding requirement for Roth conversions is a period in which the conversions cannot be taken out without incurring a 10% early withdrawal penalty. This happens to be the only early withdrawal penalty that applies to amounts that have already been taxed (the conversion was taxed in the year that it was converted).
However, after age 59.5, any withdrawal is no longer “early”. Reaching 59.5 therefore erases the penalty and the Roth conversions no longer have to be held for any period. For example, anyone over 59.5 can convert and then remove the conversion the next day with no tax or penalty.

If the conversion is done at age 57.5, then the taxpayer cannot remove any conversion dollars for two years, because age 59.5 comes up in two years and the waiting period ends then. It does not continue to 62.5.



Submitted by Robert Wright on Wed, 2009-11-04 21:18

Is this true for both converting pre-tax IRAs and pre-tax 401ks to Roth IRAs?



Submitted by Robert Wright on Wed, 2009-11-04 21:19

Also, is this true for the converted amount and the earnings on the converted amount?



Submitted by Alan Spross on Wed, 2009-11-04 21:44

Yes, there is a 5 year conversion holding period for conversions from any non Roth retirement account to a Roth IRA.

Yes, if the penalty applies to the converted amount, it will also apply to any earnings that are distributed after the converted amount. The ordering rules go in order by category:
1) Regular contributions – always tax and penalty free
2) Conversions – tax free but subject to penalty for 5 years but not after 59.5 (plus other penalty exceptions)
3) Earnings – taxable AND subject to penalty until the Roth is qualified (5 years from first Roth account and age 59.5)



Submitted by Terri Price on Wed, 2009-11-11 02:28

This is the question that I have been getting various answers on and just want to clarify what you’re saying – “actual conversion dollars (not earnings on those dollars) do not have to wait the full five year holding period as long as I’m over age 59 1/2. So if I convert “any” qualifed (tax deferred) retirement monies today (doesn’t matter whether it’s 401(k), 403(b), or IRA) and I’m age 59 and in six months I’ll be 59 1/2, I can take only those actual conversion monies (not earnings on those dollars) out without penalty and without having to have held them for the five years?

Secondly, what is the rule I’m hearing that everytime I do a conversion, I’m starting another 5 year holding period for the money I converted that particular year? Unlike a contribution to a Roth where once I’ve made a Roth contribution all future Roth contributions will meet the five year holding period based on the first year I made the contribution. In other words, I made a Roth Contribution in 2000 and every calendar year following; therefore, all contributions will have been considered to have met the five year rule even if I’m not age 59 1/2. How does this differ from what I’m hearing on ‘each’ Roth conversion has a seperate five year holding period?



Submitted by Clyde Wolf on Wed, 2009-11-11 02:57

Your ROTH IRA money is distributed in this order:
– First to be distributed is annual contributions until fully distributed.
– Second to be distributed is conversion amounts until fully distributed.
– Third to be distributed is earnings.

For annual contributions can be distributed at any time for any reason without tax and without penalty.
Conversion amounts can be distributed at any time tax free. After 5 years [b]OR[/b] age 59.5, these distributions are free from penalty.
Earnings can be distributed tax free when the ROTH IRA is 5 years old [b]AND [/b]the RIRA owner is age 59.5 or older.

After age 59.5 there is no penalty for a distribution from a TIRA. So there should be no penalty for a distribution from a ROTH IRA after that age. The reason for the 5 year wait before a penalty free distributrion on conversion amounts is to prevent someone from converting a TIRA to a ROTH, pay the tax and immediately take a penalty free distribution from the RIRA. To do this they need to do some 5 year planning.



Submitted by Terri Price on Wed, 2009-11-11 03:21

Thanks cwolf.

So here’s a strategy I have. I’ve never made any Roth contributions or conversions to date. I have a 401(k) with both after-tax and pre-tax money in it. I have MAGI under $100,000 in 2009. I take an in-service withdrawal from my 401(k) after tax amounts in 2009 before year end. Let’s say for example, they are post-87 after-tax contributions and my 401(k) is worth $500,000 and my after-tax dollars are $100,000 of that $500,000.

I request a $10,000 after tax distribution from my employer plan, and obviously, my plan will distribute those monies pro-rata based on my entire account balances as indicated above. I request a $30,000 distribution of my after-tax money. 1/5 or 20% of that $30,000 is attributable to after tax money or $6,000 and the remainder, $24,000, is considered taxable ($500K 401(K) account balance of which $100,000 is after tax). I take the $6,000 attributable to after tax money and make a $6,000 Roth IRA contribution for 2009 (I’m age 50), and take the remainder, $24,000, subject to tax and roll it over into a TIRA. Therefore, I start my five year clock as of Jan 1st, 2009 and incur no tax and no penalties on my 401(k) distribution – RIGHT?



Submitted by Terri Price on Wed, 2009-11-11 03:23

In my last post, 2nd para. I meant to say $30,000 w/d not $10,000 w/d



Submitted by Alan Spross on Wed, 2009-11-11 03:34

This strategy would work if you just changed the order somewhat.

You must roll the pre tax amount of 24,000 to the TIRA first, and then roll the 6,000 to a Roth IRA. For indirect rollovers, the first dollars rolled over are deemed to be composed of pre tax dollars, so be sure NOT to do the Roth rollover until the pre tax amount is rolled to a TIRA. You must also come up with funds to replace the mandatory 20% withholding on the pre tax amount, since $4,800 will go to the IRS for withholding, leaving you with a net distribution of 25,200. You will have to come up with the 4,800 to complete the Roth portion.

There would no tax or penalty due for the above rollovers and you would recover the withholding when you file your return.

You are correct that your 5 year clock starts 1/1/2009 for earnings to become qualified. The conversion 5 year clock is immaterial here because you rolled only after tax amounts to the Roth IRA, so you could withdraw them anytime without tax or penalty.



Submitted by Terri Price on Wed, 2009-11-11 03:52

If I’m not mistaken, I believe my employer will cut two separate checks – one for $6,000 payable to me which is considered my after tax dollars and a seperate check for the $24,000 payable to whoever I want – let’s say for example I tell them I want it payable to: “Fidelity Investments fbo Tom Jones, IRA Acct. 12345678”, therefore making the $24,000 a direct rollover and incurring no 20% withholding tax. I do physically get both checks sent to my address of record and do not have use of the check payable to my ‘currently empty skeleton’ Fidelity Rollover IRA account. I go to any Fidelity branch office and deposit my $24,000 check into my ‘already set up’ Rollover IRA account. At the same time, on the same day, I fill out a Contributory Roth IRA app and deposit my $6,000 into that for my 2009 contribution. No taxes and no penaltie.



Submitted by Terri Price on Wed, 2009-11-11 03:57

To clarify my last statement. I do have to tell my current plan trustee that I want the check payable to an existing IRA trustee and not to me in order to avoid the mandatory 20% withholding tax. And again, I can open the account in order to have an account number to give to my current plan trustee even thoough I will have not money in the Rollover account until I receive my $24,000 rollover from my employer plan.



Submitted by Terri Price on Wed, 2009-11-11 04:20

Regarding your statement, alan – “You are correct that your 5 year clock starts 1/1/2009 for earnings to become qualified. The conversion 5 year clock is immaterial here because you rolled only after tax amounts to the Roth IRA, so you could withdraw them anytime without tax or penalty.” alan-oniras

I’m planning on retiring at age 56 and at that time convert my taxable 401(k) money to a Roth Conversion account. Will a new five year clock start at age 56 for the amount I converted at that time or would I be able to use my 1/1/09 date on the $6,000 contribution I made in 2009 for those converted monies? In other words, two separate 5 year clocks for contributions and conversions.

And if I do have to start a new clock at age 56, I’ll only have to wait 3 1/2 years (until I reach 59 1/2) to be eligible to pull out the actual dollars converted with not penalties (I already paid tax)- right? What about the earnings attributable to the monies I converted at age 56? Will those also be eligible with withdrawal with no tax or penalties at age 59 1/2 or do I have to wait for five years and age 61 (earnings only)?



Submitted by Alan Spross on Wed, 2009-11-11 04:38

The earnings will be qualified after 5 years from your first Roth contribution of any type plus attaining 59.5. So if your first Roth contribution (either regular or conversion ) took place a couple years prior to the age 56 conversion, all tax and penalty on the entire Roth account will disappear at 59.5.

For the age 56 conversion, those funds are subject to penalty if distributed prior to 59.5 (unless you meet one of the other penalty exceptions such as medical, disability etc).



Submitted by Clyde Wolf on Wed, 2009-11-11 18:24

[quote=”[email protected]“]Regarding your statement, alan – “You are correct that your 5 year clock starts 1/1/2009 for earnings to become qualified. The conversion 5 year clock is immaterial here because you rolled only after tax amounts to the Roth IRA, so you could withdraw them anytime without tax or penalty.” alan-oniras

I’m planning on retiring at age 56 and at that time convert my taxable 401(k) money to a Roth Conversion account. Will a new five year clock start at age 56 for the amount I converted at that time or would I be able to use my 1/1/09 date on the $6,000 contribution I made in 2009 for those converted monies? In other words, two separate 5 year clocks for contributions and conversions.[/quote]

Yes every conversion starts a new 5 year clock for penalty only. The penalty requirement for all money in a ROTH IRA ceases to be effective at your age of 59.5. At that time there is no penalty.

The 5 year clock for penalty free eanrings that started 1-1-2009 would be completed on the later of 12-31-2013 or your age 59.5. Earnings could be distributed after the later of those times.

If you were age 58 when you first started a ROTH IRA, to receive tax free earnings you would need to wait 5 years until you were age 63.
[quote]

And if I do have to start a new clock at age 56, I’ll only have to wait 3 1/2 years (until I reach 59 1/2) to be eligible to pull out the actual dollars converted with not penalties (I already paid tax)- right? [/quote]
Yes, that is correct.

[quote]
What about the earnings attributable to the monies I converted at age 56? Will those also be eligible with withdrawal with no tax or penalties at age 59 1/2 or do I have to wait for five years and age 61 (earnings only)?[/quote]
All earnings would be tax and penalty free.
The earnings are tax free because your ROTH IRA is at least 5 years old.
The earnings are penalty free because you are age 59.5.



Submitted by Terri Price on Wed, 2009-11-11 18:41

Thank you alan & cwolf for your knowledge and widsom and thank the technology of the internet for enabling me to pick such intelligent brains just as if your desks were next to mine. terri



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