Beneficiary of a recently converted Roth IRA
Owner of a traditional IRA converted the IRA to a Roth IRA two years ago.
Owner died in 2012. Client is a non-spouse beneficiary of the converted Roth IRA.
How does the 5 year holding period rule on Roth Conversions apply to the
Roth Beneficiary IRA? Does the owner need to wait 5 years (an
additional three years in this case) until he can withdraw earnings from
the Roth Beneficiary IRA without being taxed and possibly penalized?
Permalink Submitted by mk foss on Thu, 2012-08-09 17:35
There ae a couple of 5-Year rules in play here.
A nonspouse beneficiary takes benefits from a Roth IRA using a 5-Year rule or using life expectancy. The life expectancy is usally preferable, it’s very flexible because there are small minimum distributions and you can take out more than the minimum without a problem. With the 5-Year rule as a beneficiary, the Roth must be completely withdrawn by the end of the year that contains the five year anniversary of the death.
The other 5-year rule concerns earnings. Roth earnings are taxable if withdrawn in the first 5 years the account is open. However, all of the Roth contributions and conversion amounts come out first. Assume the converted amount was $80,000 and at the time of death the account is $90,000. The $80,000 comes out tax-free at any time; none of the extra $10,000 is assumed to be withdrawn until the $80,000 is gone. So in this case, if the beneficiary uses life expectancy – they can take small (or not so small) RMDs until the account is 5 years old. At that point, there is no tax no matter how large the withdrawals are.
There are penalties when not enough is withdrawn from the Roth. If the 5-year rule is used, 50% of the balance remaining after the 5 year period is the penalty. If life expectany is used, 50% of that particular year’s RMD is the penalty.