Premature distribution from a Roth conversion
I have a 45-year old client who needs to withdraw his entire IRA balance (about $50k). Instead of getting hit with the full tax amount + 10% penalty in one tax year, I’m thinking he should first convert the IRA to a Roth IRA and then take a full withdrawal of the proceeds from his Roth conversion. I recognize that he would still have to pay the 10% penalty tax since the converted funds would be withdrawn prior to the 5-year anniversary, but wouldn’t he still be able to split the ordinary income tax over two tax years instead of paying it all up front?
Thanks in advance for your help!
Kyle
Permalink Submitted by Alan Spross on Mon, 2010-06-21 21:08
Kyle,
The 2010 conversion rules are designed to eliminate any “cash flow” advantages in doing a Roth conversion.
Amounts that would normally be deferred to 2011 and 2012 are accelerated into the year of distribution, first from 2012 amounts and last from 2011 amounts. For example, a conversion of 100,000 that was distributed in 2010 would not only be subject to the early withdrawal penalty, but the taxable income would have to reported in 2010 also.
Instead, if the distribution was delayed until January, 2011, then all the income would have to be reported in 2011. If only 20,000 was distributed in 2011, then the reportable income would be 70,000 in 2011 and 30,000 in 2012. To avoid any acceleration in income reporting, distributions must be delayed until 2012.
The client therefore should just take the distribution from the TIRA. Perhaps some of his expenses will qualify for one of the penalty exceptions in Sec 72t. If not, by splitting the distribution between 2010 and January 2011, he might be able to avoid an escalation of his marginal tax bracket.
Permalink Submitted by Kyle Bigler on Tue, 2010-06-22 06:22
Alan,
Thank you SO much for your answer. Very well written…clear and understandable. I should have known the loophole wouldn’t exist. I guess the fact that I posted the question here indicates that I had my concerns.
Thanks again. Very helpful!