Roth Conversion

Submitted by John Nielsen on Tue, 2014-06-03 20:50

I have a client who is age 64 and is considering making a substantial Roth IRA conversion in 2014. Since he is past the “safe harbor” age of 59 1/2, but has not met the 5 year test as far as owning a Roth IRA previously for purposes of qualified distributions, would this throw a wrench into things after the conversion takes place? He may need to take funds out of the Roth Conversion account prior to 5 years. It seems to me that I have read somewhere before that there could be a special penalty tax for doing so since it would be deemed a non-qualified distribution. Or is he safe (and be able to take tax-free income since he is older that 59 1/2)?



Submitted by Alan - IRA critic on Tue, 2014-06-03 21:03

The conversion should not be a problem with respect to future distributions from the Roth. Under the Roth ordering rules for non qualified distributions, client’s regular contributions come out first tax and penalty free, then conversions in his case also tax and penalty free. The 5 year holding period for each conversion no longer applies after age 59.5, so he could withdraw the entire conversion anytime without tax or penalty. Only his earnings will be taxable if he withdraws more than all his contributions and conversions. Since he probably does not have much in earnings in his Roth, as long as he leaves at least the amount of his earnings in the Roth until he meets the 5 year qualification period, there will be no taxes due.

Submitted by John Nielsen on Tue, 2014-06-03 21:52

Thank you.

Submitted by Christopher Nolan on Tue, 2014-06-10 02:35

Re: “Roth IRA conversions usually don’t make sense if you have to dip into your tax-deferred retirement savings or the potentially tax-free Roth you’ve just created to (help) pay for the conversion. The math simply doesn’t add up. That means that in order to make a Roth conversion worthwhile you generally need to have enough outside money (i.e., cash in the bank, money invested in a taxable account) to pay the tax on the conversion.”I understand the above logic if one were under 59 1/2, that is, to avoid a 10% penalty; but, at age 60, what is the advantage of “outside money” vs. just having the federal and state taxes deducted from the IRA Roth conversion amount? Regardless of where the tax money comes from, outside money or from the IRA conversion money, the loss of investment earnings will occur on the amount paid for taxes. So, what is the advantage of paying taxes with “outside money” after age 59 1/2? My specific situation: Age 60, with desire to terminate my large sole-participant Defined Benefit Plan in 2014, incur the maximum federal rate (39.6%) and state rate (6%) now, paid for as tax deductions to be remitted by the Plan Administrator upon termination and trustee-to-trustee transfer of fund to a Roth IRA. My reasoning for converting now: the Roth IRA can be entirely accessed tax-free in 5 years at age 65, with future growth and legacies also tax-free, with no RMD for me at 70 1/2. Please explain, and thank you. – See more at: http://www.theslottreport.com/2014/04/3-reasons-to-wait-until-you-retire-to.html#comment-form

Submitted by Alan - IRA critic on Tue, 2014-06-10 03:47

  • FIrst, you need to be sure that the Roth conversion will be beneficial before the tax source is considered. Loss of nearly have your distribution to taxes is not beneficial unless you expect to always be in that tax bracket in retirement. Incremental conversions usually work better to control the taxes on the conversion. Perhaps you you would be better off rolling the plan to your TIRA and then converting incremental amounts.
  • If you have taxes withheld from the TIRA distribution, you lose tax deferral for that part of the distribution. You have a smaller Roth and lost tax deferral on the portion that did not get converted due to withholding. But after 59.5 when the penalty is no longer an issue, and you are cash poor and TIRA rich, it may not matter too much.

  

Submitted by Christopher Nolan on Thu, 2014-06-12 03:01

Again, thank you.      

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