5 yr holding period
Concerns regarding the 5 yr period for roth. 78 yrs old, still working. 75 yr old non-working spouse. Plan on converting $40,000 to a roth in 2010. Spouse is beneficiary, 2 sons are contingents. If death occurs before the 5 yrs I know that my spouse can treat the Roth as her own. What happens if she than passes before the 5 year period and the sons inherit the Roth and begin taking distributions based on their life expectancy? Will the earnings be taxable since the Roth has not been opened for 5 years?
Also would like to start a separate contributory Roth, putting in $6,000 a year for the next 3 yrs, while still working. Are converted amounts added to income in figuring the income limit for Roth contributions.
Permalink Submitted by mk foss on Mon, 2010-12-20 18:36
The 5 year holding period only applies to earnings. If you establish an IRA and pass away before 5 years – the balance of the 5 year period could still cause some earnings to be taxable. If spouse inherits and passes away before your 5 year clock had run out – the ultimate beneficiaries would still have to worry about potential tax on earnings. However, there are ordering rules on distributions – the earnings are the last things withdrawn. The only possibility of having any tax consequence with 2 deaths within 5 years would be if the Roth was cashed out shortly after the second death.
The order of withdrawals is: (1) contributions; (2) taxed conversion amounts (3) untaxed conversion amounts (basis) and (4) earnings.
If you establish a contributory Roth – it will provide additional funds withdrawn tax-free first but won’t have a negative impact.
Permalink Submitted by Alan Spross on Mon, 2010-12-20 18:50
If you convert to a Roth, the conversion income will NOT be counted for purposes of determining if your income is too high to make a regular Roth contribution, ie the conversion income is subtracted from AGI to determine modified AGI.
Permalink Submitted by Lee Mertisnon on Tue, 2010-12-21 18:52
Wait, mgtf4cpa, can we get clarification? Original poster talked about a conversion and a separate contribution and also there are two different kinds of taxes here.
10% Penalty For Early Withdrawal:
On a [i]conversion[/i], my understanding is that the [i]conversion[/i] 5 year holding period applies to all money (not just earnings), and would cause an early withdrwal 10% penalty on any monies withdrawn by the owner before the 5 year period is up. But that a beneficiary of the deceased owner would have no 10 % early withdrawal penalty on any of that money, no matter how much is withdrawn (including earnings).
Ordinary Income Taxes:
But furthermore even that beneficiary could have ordinary income taxes on the earnings portion of a withdrawal if withdrawn before the 5 year holding period. (Even though they would have to withdraw most of Roth plan for that to happen).
Right?
Permalink Submitted by Alan Spross on Tue, 2010-12-21 19:09
Yes, correct.
But Mary Kay did not mention the 5 year conversion holding period because the owners passed age 59.5 several years ago. Therefore, only the “other” 5 year holding period was material, ie the one that determines when the entire Roth is qualified.
Permalink Submitted by mk foss on Tue, 2010-12-21 19:15
The 10% penalty for early withdrawal applies to a conversion for 5 years (if the Roth owner is under 59-1/2 all 5 years) on withdrawals of the converted amount. If a beneficiary inherits a Roth created by conversion the balance of the 5 year period for exposure to the 10% penalty goes away. There is no 10% penalty on inherited Roth distributions.
If someone inherits a Roth within 5 years of the owner establishing ANY Roth – there could be a tax on the earnings if massive amounts are withdrawn.
I didn’t mean to imply that someone inheriting an IRA would have a 10% penalty.I do think that paying a 10% penalty on a conversion is more likely for a Roth IRA owner, than paying income tax within 5 years paritally because when someone is avoiding income tax, they forget about any associated penalties.