Attn. alan oniras and eczaporea : Re 5 Year Wait to Withdra
Folks
(Apologies for this awkward means of responding; I haven’t figured out how to post a response to your answers directly.)
Having two different people provide slightly different perspectives in their answers has allowed me, after very careful consideration, to recognize something I was unaware of: the definition of “contribution”. To a lay person, ANY money invested in a Roth IRA is a “contribution”. However, you have shown me that, in IRA-ese, only after-tax savings invested by a wage earning person in a (Roth) IRA are considered “contributions”. The only other way of funding the Roth IRA is from a traditional IRA or rollover from a 401k, and this is NOT considered a “contribution”, but instead an entirely different animal, a “conversion”. You indicate “converted” monies ARE subject to a less-than -5-year penalty, albeit a 10% one rather than a tax one.
Although I had never anticipated this complication, may I make a nit-picking observation regarding my original question? I said the Roth was “opened” with $10K. I believe even a Roth has a limit on how large a “contribution” can be made in it each year, and it is substantially less than $10K. Hence, at least part of that $10K must have been a “conversion”, as well as with the second $10K. Thus, with 3 years to go, at least part of the $15K distribution must be subject to the 10% penalty.
Thank you for helping clarify this issue.
DBRJ
Permalink Submitted by Edward Czapor on Fri, 2010-02-05 18:22
Yes you are correct regarding the fact that conversions were involved in your example which was missed. However the 15k withdrawal would still be tax and likely penalty free due to the ordering rules. Assume that the 10k amounts consisted of a 5k contribution and a 5k conversion. The 15k withdrawal would then consist of 10k contributions and 5k from the first conversion. Since the first conversion has been held over 5 yrs. there is no penalty on the converted amount even if under 591/2 years old. If the 15k consisted of any converted amounts from the 2nd conversion, then that amount would be subject to the 10% penalty if under 591/2 because that conversion has not been held at least 5 years. In either case there is no tax on the amounts converted. If a Roth is started by a conversion it is the same as a contribution for the 5 yr. rule for taxation of earnings. This 5 yr. period starts Jan. 1 of the conversion year, same as a contribution.
Permalink Submitted by david johnston on Fri, 2010-02-05 19:13
Are you suggesting that the 10% rule only applies if the owner is under 59.5yr?
Or, that withdrawals from an account, opened with a conversion, may may be made, 10% penalty free, in under 5 yrs, if the owner is (then) over 59.5?
Your “Jan 1” observation was interesting.
DBRJ
Permalink Submitted by Alan Spross on Fri, 2010-02-05 22:04
Yes, that is correct.
Once you reach 59.5, ALL early withdrawal penalties no longer apply. There is no longer a 5 year holding period for conversions to be distributed penalty free or any other early withdrawal penalty. Even if the Roth earnings are still taxable because the account is not yet qualified, there is no penalty on those earnings, just ordinary income tax.
Permalink Submitted by david johnston on Sat, 2010-02-06 17:53
Re the “Jan 1 rule”. Joe, 54 yrs old, makes a $1K contribution along with a $1K conversion to open a new Roth on Dec 31, 2000. He is forced to withdraw $2K plus half of his earnings on Jan 2, 2005. The $1K contribution is tax and penalty free. Has he attained the 5 years credit to allow withdrawing the $1K conversion without any 10% penalty or the earnings without 10% penalty plus tax on them?
Alternatively, if Joe was 60 initially, then the $1K contribution and the $1K conversion are both tax and penalty free. Has he attained the 5 years credit to allow withdrawing the earnings without tax on them?
Thanks.
DBRJ
Permalink Submitted by Alan Spross on Sat, 2010-02-06 18:24
As long as the Roth conversion contribution is recorded by the Roth custodian by 12/31/2000, the 5 year conversion holding period ended 12/31/2004 and the distribution of the conversion dollars would not incur the early withdrawal penalty. The 5 year period begins January 1st of the year the Roth conversion is completed.
On 1/2/2005, distributions of earnings are tax and penalty free ONLY if he has reached 59.5 on that date or is totally disabled. If not yet 59.5 to the day, the earnings will be taxable and subject to penalty.
In your alternate question, the Roth is fully qualified upon reaching 5 years as of 12/31/2004, so all distributions after that date are tax and penalty free.
Permalink Submitted by david johnston on Sat, 2010-02-06 19:55
Your patience with me is remarkable – and appreciated.
So – in my second case, if the withdrawal were to be made 6 months earlier, since Joe is over 59.5 yrs old, he is not subject to any 10% penalties, and both his contribution and conversion are tax free. However, his earnings WILL be taxed. I think I have it.
Thank you.
DBRJ
Permalink Submitted by Alan Spross on Sat, 2010-02-06 21:58
Correct.