ROTH IRA Conversion and subsequent distribution before meeting 5 year rule
My client has a ROTH IRA from a conversion of his IRA annuity that has an income rider. He wants to elect to turn on the income from his rider in 3 years. He meets the over 59 1/2 but not the holding period of 5 years. According to everything I’ve read, the distribution taxation is as follows: contributions/conversions/earnings. The insurance company is saying that because he didn’t meet the 5 years from conversion that they are going to code the distribution as a code J which is early distributions (that didn’t make sense since he is over 67). They went on to clarify that because this is considered a systematic payment and it did not meet both parameters to be a qualified ROTH that this is the way it needs to be coded for each distribution until the 5 year rule has been met. Can you please clarify this ? How would they even calculate what would be taxable? Thank you.
Permalink Submitted by Alan - IRA critic on Wed, 2025-03-12 12:22
They should be using Code T, as they know he is over 59.5. That said, the distribution is not qualified and will have to be reported on Form 8606, so the J code has no real downside.
The Roth IRA ordering rules apply, but he will have to know the regular Roth contribution basis to enter on line 22 of Form 8606 (if he owns other Roth IRAs, they are all treated as one combined Roth account). If the line 22 amount does not exceed the amount distributed, then the conversion amounts go on line 24. Those also come out tax free (and penalty free being over 59.5). There will be no income tax due until the amount distributed exceeds both the regular and conversion basis amounts.
Roth custodians have no way to know if a distribution will be taxable or not unless their own account has been held 5 years and the Roth owner is also over 59.5. If the Roth owner knows that the distribution is qualified, Form 8606 is not needed, and the distribution only goes on line 4a of Form 1040. If the Roth is not qualified, then the Roth owner must determine the amounts to enter on Form 8606. If the owner has not kept track of Roth regular contribution and conversion basis, reporting a NQ distribution will require research to determine what those figures are.
Unfortunately, most Roth owners do not keep track of their Roth basis. Tax programs can track it if all contributions have been entered, but when changing programs, the cumulative basis must be entered into the new program. That often does not happen because regular Roth contributions are not reported on the tax return.