Roth 5 year rule and Roth Converstion

Submitted by Nick Pappas on Fri, 2014-06-20 16:25

I know the 5 year applies to beneficiaries based on the date the original owner opened account but are the RMD’s exempt from penalty if its before 5 years? If not exempt do the ordering rules apply so that they RMD could be contributions first to avoid penalty?

Also, is there a different 5 year rule for Conversions? Meaning if you have a Roth IRA for 2 years and then convert some TIRA funds to Roth do they get credit for the previous 2 years?

In line with this question if you convert mutiple years, is each conversion subject to a 5 year rule or the original conversion starts the clock for all future conversions?

I know this is alot of questions so thank you very much in advance.

-Nick



Submitted by Alan - IRA critic on Fri, 2014-06-20 19:06

  • There are two totally separate 5 year holding periods for a Roth IRA. The first along with reaching 59.5 determines when the Roth is qualified and earnings are tax free, therefore it only deals with tax on earnings. When the owner passes, the 5 years continues to run and is attained when the ownership plus the beneficiary holding period reaches 5 years total. But even without attaining the 5 years, there is never a penalty for beneficiary distributions because they are death benefits. For a beneficiary, if the 5 years has not been attained and distribrutions reach the earnings, they are taxable but NOT subject to penalty.
  • The second 5 year holding period relates to each separate conversion and determines when the 10% penalty is no longer due. This period does not apply to beneficiaries at all because death benefits are never subject to the 10% penalty. For an IRA owner distributions before the Roth is qualified (see 1 above) come out per the ordering rules. Conversion come out only after all regular contributions are withdrawn, and the oldest conversions come out before later ones. In 2014, all conversions done prior to 2010 have met the 5 year holding and come out penalty free. The conversion holding period also ends at 59.5 because distributions are no longer “early” after 59.5. A conversion done at 56.5 therefore only has a 3 year holding period because in 3 years the owner is 59.5. Conversions done in different years therefore have holding periods that end in different years since each year’s conversion has it’s own 5 year holding period.

Submitted by tomtom on Sat, 2014-06-21 15:00

Thank-you Alan-iracritic !!Reading Mr Slotts books and various postings here I have struggled with the nuances of just what criteria make an Inherited Roth qualified regarding earnings.  It must be exasperating reviewing this detail in so many ways.  IMHO this #2 bullet point explanation nails it.Unless I misunderstand, of course… Regards,  tomtom 

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