Qualified Roth withdrawal
I understand that per the 8606, qualified Roth withdrawals for a first time home buy (up to $10,000 per individual) will be withdrawn first from the Roth’s earnings.
But if an individual has more than one Roth and neither has $10,000 in earnings, but combined they do, will the Roth holder have to do withdrawals separately from each Roth to get to the $10,000 he wants for the qualifying first time home down payment, or can he combine them and draw from either Roth?
BruceM
Permalink Submitted by Alan Spross on Sat, 2010-02-27 19:18
Bruce,
The distribution can be taken from either Roth or in some combination from both of them. The 8606 treats all the Roth accounts as one. The oldest of the two also determines whether the 5 year holding period has been satisfied.
Permalink Submitted by Anonymous (not verified) on Sat, 2010-02-27 20:23
Also, what must be said is that your contributions (first tier out) do not need to be classified for a first homebuyer exception. So you can take out all those amounts first and do not need to specify [u]any[/u] reason. That may give you enough and you can save the 10K exception for another time OR you have more money available – all contributions plus any combination of conversions and earnings up to 10K (not sure what your Roth consists of right now).
pko
Permalink Submitted by Alan Spross on Sun, 2010-02-28 03:29
pko makes a good point.
Many IRA owners are inclined to show a qualified first home distribution on Form 8606 whether it really benefits them or not. This is an election and since there is only one 10,000 lifetime benefit, it is not wise to elect to use it or any part of that limit without getting a benefit of either waiver of an early distribution penalty in the case of conversions held under 5 years or a benefit of providing qualified status to earnings in the Roth. Another error is to show the homebuyer expenses on line 20 without noticing that the instructions indicate that it should only be shown if the Roth has met the 5 year holding period.
The IRS will (or should) apply the lifetime limit to amounts shown on line 20 of Form 8606, and it may be difficult or impossible to get relief if the amount should not have been on line 20 in the first place.
Permalink Submitted by BruceM on Sun, 2010-02-28 18:19
[quote=”[email protected]“]Also, what must be said is that your contributions (first tier out) do not need to be classified for a first homebuyer exception. So you can take out all those amounts first and do not need to specify [u]any[/u] reason. That may give you enough and you can save the 10K exception for another time OR you have more money available – all contributions plus any combination of conversions and earnings up to 10K (not sure what your Roth consists of right now).pko[/quote]
A qualified Roth withdrawal for a first time home only qualifies for a first time home, so not sure if there would be any benefit to doing it now or waiting for a future first time home.
But if one qualifies for the FTH, it would seem to make the most sense to use the earnings rather than simply withdrawing basis, as one could do at any time prior to age 59.5 without tax or penalty.
Alan: I find it interesting that for purposes of qualified withdrawal for a FTH, that all Roth’s are combined…whereas for a recharacterization, it would seem to be done by Roth account.
BruceM
Permalink Submitted by Anonymous (not verified) on Sun, 2010-02-28 19:18
Bruce:
My post actually describes the ordering rules out of a Roth, so you have no choice [u]only[/u] to take earnings first, ie. this is the order distributions must follow:
1.Contributions
2.Conversions
3.Subsequent Conversions
4.Earnings
As for the First Homebuyer exception definition. It does not mean only your very first home. You could own a home and after a period of having no interest in a home for two years, that exception applies again. Ofcourse, you only have the 10K available as a lifetime amount (and your spouse too).
I can’t expain why the aggregation for distributions and not for recharacterizations. I guess those are the rules…..
pko
Permalink Submitted by Alan Spross on Sun, 2010-02-28 22:32
The qualified first home distribution is by far and away the most complex Roth transaction and easily the most misunderstood. In fact, it is so complex I have never seen an article attempting to analyze the planning elements with respect to this distribution. Here are some of the elements that contribute to the complexity:
1) Properly identifying all the requirements for such a distribution
2) The unique concept that a single distribution can be partially qualified and partially unqualified if more than the qualified FH amount is distributed. This means that the ordering rules ONLY apply to the unqualified portion of the distribution. Ordering rules do NOT apply to qualified distributions. Line 21 of Form 8606 produces that result.
3) If all Roth accounts have aggregate earnings, the distribution is applied first to earnings before basis.
4) BUT… in the following year, your basis is reduced by the amount of tax free earnings applied in the prior FH distribution, which means effectively that earnings are restored to the account and basis reduced. That makes the FH distribution only a temporary and over rated benefit, ie. it was tax free even though it may well have been tax free under the ordering rules without the FH election. Then, if the FH distribution is elected, any earnings that come out tax free result in a basis reduction in the following year. This is done via the chart on p 8 of the 8606 Inst which determines the amount of basis on line 22 for subsequent distributions.
Permalink Submitted by Edward Czapor on Mon, 2010-03-01 01:54
Alan,
I question whether the 10% penalty for Roth conversions held less than 5 yrs. can be alleviated by the FTH exception. Note that the definition for FTH “distributions” for line 19 of Form 8606 as defined in 2009 Pub. 590 pg. 53, is NOT the same as FTH ” qualified expenses” for line 20 as explained on pg. 7 of Form 8606. Line 20 is limited to amounts from contributory or conversion Roths held at least 5 yrs. If a Roth consisted only of a conversion held less than 5 yrs., it would not be entered on line 20 and would be subject to penalty on converted amounts and taxed earnings. If a conversion was held at least 5 yrs., it could be entered on line 20, there would be no 10% penalty on the converted amount regardless, and up to 10,000 of earnings could be qualified due to the FTH exception and therefore tax and penalty free.
If you recall, we had a discussion on the FTH exception for a Roth sometime last year. At that time I believe we agreed that the ordering rules would apply, and that earnings could not in effect be be withdrawn first.
Ed C.
Permalink Submitted by Alan Spross on Mon, 2010-03-01 04:04
Hi, Ed – yes, I recall the discussion but not necessarily the varied conclusions. That is when I discovered how many variations exist with the outcomes related to FH distributions. Testing a number of different scenarios, I found it very difficult to come up with general statements since there are so many possible outcomes based on the composition of someone’s Roth IRA when they claim the FT distribution.
To that end, you are correct that line 20 should not list FH expenses unless they have a Roth (any of their Roths) held 5 years per the Inst. However, even if the Roth has NOT met the 5 year holding period and was formed by a conversion, the early withdrawal penalty should be waived per the general list of early withdrawal waivers that includes this type of expense. These are listed on p 66 of Pub 590 (4th bullet point) as exceptions to not holding a Roth conversion 5 years. Therefore, the Sec 72t penalty can be waived when the distribution is NQ. You would have to add a 5329 with a code of “09” to claim the penalty exception. This brings up the need for the IRS to track use of the 10,000 limit. For the IRS to monitor the 10,000 limit, it seems like they would have to add amounts shown on line 20 of Form 8606 to amounts shown on 5329 as a FH penalty waiver. These are not different 10,000 limits either since the Qualified Roth ST distribution described on p 64 refers back to the Chapter 1 penalty exceptions on pages 51-53.
Regarding our earlier discussion, I think the conclusion was as indicated in point 4 of my prior post, that with a qualified FT distribution properly listed on line 20 of Form 8606, that distribution is qualified for that portion, and earnings come out first tax free. But as indicated earlier, there is no lasting benefit unless you close all your Roths that same year. If you don’t the chart on p 8 of the 8606 Inst effectively takes the earnings you took out tax free in a prior year and reduces your basis that goes on line 22 of the 8606. When you reduce basis, you restore earnings in the Roth. But note even this conclusion assumes no change in value due to the holdings, since if they drop earnings are snuffed out anyway.
I think this exception is overrated as to it’s value. If you use your TIRA, it simply wipes out the 10% penalty. If you use your Roth IRA, all sorts of scenarios unfold, which I why this is so dang complex.
Permalink Submitted by Edward Czapor on Mon, 2010-03-01 05:31
Thanks Alan, and of course you are correct as usual. I knew that the 10% penalty on Roth conversions should be waived with the FTH exception. Concentrating on the Form 8606 itself does not come to this conclusion since such a distribution ends up on line 23. Form 8606 line 23 states you may be subject to additional tax, and the instructions for line 23 refer you to Form 5329 and exceptions such as 09. Got confused which is easy for me. I agree that the FTH exception is of little value especially for a Roth when the ordering rules will usually provide a tax free dristribution. From the posts on this board, I think there is also too much concern for the 5 year rules which probably won’t affect most distributions. And the 10% penalty on Roth conversion amounts would have been due anyway if withdrawn from a TIRA.