Roth Conversion Penalty
Up until 2010, I made non-deductible Traditional IRA contributions and did a small rollover to the traditional IRA in 2009 (paying taxes at that time on the rollover). In 2010, I converted the entire traditional IRA to a Roth. In 2011 and 2012, I did a “backdoor” Roth contribution by contributing to a traditional IRA and immediately converting to the Roth.
So, I guess I have no Roth IRA “Contributions”. I have 3 Conversions (2010, 2011, 2012). I opened the Roth in 2010. Can I take out the “converted” money at any time without tax or penalty? What about the earnings? Does each conversion begin a new 5-year period? I’m currently 54 if that makes any difference. Thanks.
Permalink Submitted by Alan Spross on Mon, 2012-10-29 17:54
You can take out the converted money anytime without tax. However, if you are under 59.5, you must hold Roth conversions for 5 years to avoid a 10% penalty on the taxable amount.
For example, if you filed Form 8606 for the years you made non deductible TIRA contributions, your 2010 conversion was partially taxable. If you take a distribution, the oldest conversions come out first, and the taxable portion of each year’s conversion before the non taxable part. If your 2010 conversion was 20k and 5k was taxable (see your 2010 8606), the first 5k out will have a 10% penalty, the next 15k will be penalty free because it was not taxed when you converted. Your 2011 and 2012 conversions should be penalty free as well since they were not taxed when you converted. Any earnings will come out last, and will be subject to both tax and penalty until you reach 59.5 AND have held your Roth for 5 years.
Your 2010 conversion will become penalty free in 2015 for the taxable portion of that conversion.
Permalink Submitted by patrick Austin on Mon, 2012-10-29 19:48
Thanks for your quick reply Alan. I just want to clarify something:
So, using the numbers in your example for the 2010 conversion ($5K taxable, 15K non-taxable), if I were to take out say $7K this year, I would owe a penalty of $500 (10% of $5,000) even though I paid the tax on that portion in 2010?
Once I reach 59 1/2 is there ever a scenerio where I would owe tax (or penalty) on ANY conversions to a Roth (even the conversions that aren’t yet 5 years old? Thanks again for your help. This Roth stuff is complicated!
Permalink Submitted by Alan Spross on Mon, 2012-10-29 20:26
Correct, you would pay the 10% penalty on the $500 taxable portion because the 5 year conversion holding period was not met. However, you might qualify for a different penalty exception if you have certain medical expenses, higher education, disability, or first home purchase.
When you reach 59.5, your Roth will be fully qualified as you will also have met the 5 year holding requirement, and there will be no further taxes or penalty on the entire balance.