Roth IRA withdrawals
I am trying to understand the 5 year rule for withdrawals from a Roth IRA. Does all of a conversion from a TIRA to a Roth have to be in the Roth for 5 years from conversion date, or can the amount of the conversion be withdrawn without penalty if the TIRA had been in place 5 years prior to conversion, taxes paid on conversion amount that was not part of the basis in the TIRA, and over age 59 1/2? I have tried to understand the rules in IRS Publication 590, but find it very confusing. I have heard that contributions to Roth IRA’s can be withdrawn before 5 years, but if earnings are withdrawn they are taxable. I need some clarification on this point.
Also, if a qualified distribution if made from a Roth, does a Tax Form 8606 need to be filed? Thanks.
Permalink Submitted by Alan Spross on Thu, 2011-03-24 00:20
Last question is easier, if the entire Roth is qualified, ie 5 year holding and age 59.5, no 8606 is needed. The distribution is only reported on line 15a of Form 1040. But if the distribution is qualified only because it is a first home distribution, then the 8606 is needed.
First question relates to the ordering rules, which only apply prior to qualification of the entire Roth. Regular contributions come out first both tax and penalty free; next come Roth conversions starting with the oldest and if a conversion had basis, the pre tax portion first. Once conversions come out that are held under 5 years, no tax is due but the early distribution penalty applies to the pre tax amount UNLESS an exception is met, most commonly being 59.5. Last out are earnings, subject to both tax and penalty unless a penalty exception applies.
The pitfall here is that very few people maintain adequate records to report non qualified Roth distributions. A non qualified distribution must be reported on Form 8606 even if it is tax free, and the appropriate balances of the various types of contributions are required to complete the 8606 correctly. Some form of tally sheet is best to keep track of these balances by year, but if distributions are taken the balances are reduced. Eg if you made 15,000 of regular contributions but then withdrew 10,000 tax free, your balance for the next distribution is down to 5,000 plus whatever new contributions you made after the last distribution.
With a Roth IRA you just hope to hold it until it is qualified before making distributions to not only avoid the complex reporting, but also to generate tax free earnings.