Roth Conversion Withdrawals-5 yr rule
A CPA called me with a client problem. In 2005 the client converted 100k from a Traditional IRA to a Roth IRA and it went into brokerage account A. In 2006 the client converted 50k to account B and in 2007 converted 75k to account B. In 2010 he took out 100k from acct B and now is being penalized by the IRS for not holding the money for 5 yrs. Is the IRS correct? Why can’t the client treat the 100k withdrawal as though it came from account A, which allows him to meet the 5 year rule? Would this be an issue if the client combined account A into account B and then took the 100k withdrawal? How is this even tracked by the IRS?
Thank you!
Permalink Submitted by Alan - IRA critic on Tue, 2013-09-17 22:23
Since all Roth IRAs are considered one combined account for tax purposes, and the ordering rules state that older conversions come out before later ones, the 2010 distribution is deemed to have come from the 2005 conversion and the 5 year holding period for the 2009 conversion ended 1/1/2010. There should be no penalty, but combining accounts is immaterial to the problem. Most likely, the IRS observed a distribution of conversion money on line 30 of Form 8606 and no penalty exception was filed on Part I of Form 5329. This is resolved by filing a 1040X with a 5329 showing exception code 12 and explanation that the full 2010 distribution came from 2005 conversion money.
Permalink Submitted by Jonathan Sard on Wed, 2013-09-18 01:28
Is there a code section or something from the IRS website that states that all Roth IRAs are considered one combined account for tax purposes and that the ordering rules state that older conversions come out before later ones. Below is the information I found on the IRS website and is why I am confused about this topic. I underlined the sentence that states that a separate 5 year ruld applies to each conversion. I am very confused! Thank you for your help and guidance!Additional Tax on Early DistributionsDistributions of conversion and certain rollover contributions within 5-year period. If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount). A separate 5-year period applies to each conversion and rollover. See Ordering Rules for Distributions , later, to determine the recapture amount, if any.
Permalink Submitted by Alan - IRA critic on Wed, 2013-09-18 02:54
Take a look at Pub 590, p 72 here: http://www.irs.gov/pub/irs-pdf/p590.pdf . First, the ordering rules describe the parts of a Roth IRA that are distributed in order. Then the aggregation rules indicate that the totals from all your Roth IRAs are combined. This is all reported on Form 8606, and there is only one 8606 form for all Roth distributions regardless of how many Roth accounts exist. The instructions for Form 8606 indicate what balances to enter on the various lines to determine any tax or penalty due for Roth distributions. The only time when you do NOT combine all Roth accounts is when you are correcting an excess contribution, but that does not involve Form 8606. In summary, it makes no difference how many Roth accounts you have for distribution reporting or even for contributions. If each Roth account was considered separately, you could open dozens of them and make a full contribution to each one, or for distributions you could choose which one to take the distribution from and get different treatment than taking it from another account. But the rules combine all your Roth accounts as if they were one.