TIRA to Roth Question
I have looked at many of the threads and even the IRS pubs talking about transferring a Traditional IRA to a Roth IRA. I just would like to verify my overview.
I am 60 and will be transferring some very depressed assets from my TIRA to a new Roth opened this year. I understand I can withdraw the converted amount at anytime tax free. However during the 5 year holding period, until I can withdraw earnings tax free, I will have to pay regular income tax but no penalty on earnings withdrawls. So during that 5 year period if I withdraw earnings the tax consequence will be the same as if I had withdrawn them from my TIRA. That means I don’t lose anything by transferring the assets to the Roth even though I may need to withdraw some of the earnings prior to the 5 year holding period. Is this a correct assesment?
TIA
Permalink Submitted by Alan Spross on Sat, 2010-04-17 19:28
Partially correct.
It sounds like this will be your first Roth IRA so you 5 year holding period for earnings qualification will begin 1/1/2010. Until 2015, any distributions you take from that Roth IRA follow the “ordering rules” since your Roth is not yet qualified. Under the ordering rules, your earnings generated in the Roth IRA will come out last, after your conversion amount has been fully distributed. Starting out with no earnings makes it unlikely that you would ever reach your earnings within 5 years unless you pretty much drained the entire account. That would probably happen only in an emergency, otherwise you probably would not bother to convert in the first place. You should also have funds available to pay the conversion taxes from outside sources rather than paying them from IRA distributions.
There is another issue when you convert in 2010. Unless you opt out, the conversion income will be reported half in 2011 and the other half in 2012. HOWEVER, if you withdraw conversion dollars prior to 2012, you will accelerate the income tax that is deferred into the year you took the distribution. For example, if you converted 30,000 this year (and had no prior Roth IRA), any distribution you take this year would be taxable this year instead of in 2012. Without a distribution, a 30,000 conversion would be taxable @ 15,000 in 2011 and 15,000 in 2012. But if you then withdrew 10,000 before the end of this year, your conversion income would be reported @ 10,000 in 2010, 15,000 in 2011 and 5,000 in 2012.
Permalink Submitted by James Cruce on Sat, 2010-04-17 22:37
Thanks for your thoughts.
I appreciate your reminder about deffering the income tax due. I got so caught up in the earnings withdrawal issue that I forgot the special tax benefits of 2010.
I asked about taking earnings since the Roth will be funded with stocks that might double or more over the next 1 – 3 years. If the gains are really large I will probably start drawing some of the earnings before the end of the 5 year holding period. I know there are no guarrantees on performance. However, if I took some of the earnings before the end of the 5 year holding period, I wanted to verify that the cost would be the same as taking it out of the TIRA.
Permalink Submitted by Alan Spross on Sat, 2010-04-17 23:58
If your distributions exhausted your converted amount and earnings were then distributed, they would be taxed at ordinary income rates as if you took a distribution from the TIRA. Just wanted to be sure that you knew earnings came out last.
Example: You convert 20,000 by transferring stocks from your TIRA to a Roth IRA. After a couple years the stocks double so your Roth is now 40,000. The first 20,000 you would take out would be the converted amount tax and penalty free. You could only withdraw earnings after you had already taken out 20,000, which is a positive. And starting in the 6th calendar year, the Roth is totally qualified and tax free.
Permalink Submitted by James Cruce on Sun, 2010-04-18 04:58
Thanks again. I appreciate your taking a look at my scenario and providing your input. It did give me some new ideas.