5-year rule for Roth conversions
A young person (now in her late 20s but on the right track) set up a Roth IRA and contributed to it when she was in school and had summer jobs, the year she finished school and started working in the middle of the year, and the year she changed jobs and took some time off between jobs. Every other year she was over the income cap, so she contributed to a traditional IRA (even though she couldn’t deduct the contributions) and immediately thereafter converted to a Roth. Also, when she changed jobs, she rolled her Roth 401(k) over into a Roth IRA.
Which of these does she have to keep separate for 5 years, and which can she combine?
While she doesn’t expect to ever need any distributions, she’d like to be protected as much as she can from any penalties on distributions within 5 years.
Permalink Submitted by Alan Spross on Wed, 2012-11-21 22:46
Bruce,
She could combine them all, but would need to keep track of her basis in regular contributions and conversions either way. Even if she withdrew conversions in less than 5 years, there is no 10% penalty except on the taxable portion of the conversion and her conversions were totally non taxable or very close to it.
The Roth 401k rollover was from non qualified Roth funds. Her 1099R for that rollover will show the amount of her contributions, and the amount shown on the 1099R in the contribution box will be considered the same as Roth IRA regular contributions. The amount of the Roth 401k rollover that exceeded the amount shown as contributions is treated as Roth IRA earning once the funds reach her Roth IRA.
At any point in time her Roth IRA breakdown for reporting the distribution on Form 8606 would be:
1) Regular Roth IRA contributions = Regular Roth IRA contributions + amount shown on the 1099R as Roth 401k contributions
2) Conversions = amount actually converted from her TIRA to Roth IRA
3) Roth IRA earnings = Total Roth IRA value less 1) and 2) above.
She needs to keep track of those values whether her Roth IRAs are combined or she keeps certain ones separate. But since they are all aggregated for tax purposes, there is no need to keep separate Roth IRA accounts. If and when she ever converts taxable amounts to a Roth IRA, she may keep those conversions in separate Roth IRAs until the recharacterization deadline passes, although the Roth custodians are normally able to handle recharacterization earnings calcalutions even when all Roths are kept in a single account.