Roth Conversions and Contributions, Creditor Protection Highlight Mailbag

By Beverly DeVeny, IRA Technical Expert

Follow Me on Twitter: @BevIRAEdSlott

This week’s Slott Report Mailbag includes questions on Roth conversions and contributions, the always-confusing Roth IRA 5-year rules and creditor protection for IRAs. Happy a happy, healthy Memorial Day weekend and thank you to the servicemen and women who risk their lives daily to defend and protect us. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Hello,

I have purchased Ed Slott’s program guide package. It’s very helpful. Thank you very much.

I have a question regarding a Roth IRA conversion. There is no limit to convert from tradition IRA to Roth IRA. Can I contribute the $5,000 limit to a Roth IRA in the same year I convert the traditional IRA to Roth? In other words, will the amount I convert be counted as part of the contribution?

Thanks for the advice,

Tony

Answer:
Roth conversions are in addition to the amount you can contribute annually to a Roth IRA. You can convert $100,000 (or any other amount) to a Roth IRA and still make a contribution to any Roth account. Anyone can do a Roth conversion at any age. In order to make a Roth contribution, you must first have earned income (compensation) and your income cannot exceed certain limits. If you are married, filing jointly, your ability to contribute to a Roth IRA will phase out when your modified adjusted gross income is between $173,000 and $183,000. For individuals who file as single or head of household, the phase-out range is $110,000 to $125,000. You can find more numbers from 2012 IRA and tax tables at www.IRAhelp.com/2012.

2.

I have one question about the 10% penalty on non-qualified distributions.

Assumptions: I made my first Roth contribution 10 years ago. I converted an IRA to a Roth two years ago. Today I attain age 59 ½. Tomorrow I will take a distribution attributable to the Roth conversion.

The distribution will be a qualified distribution because I will be over age 59 ½ and I will have made my first Roth contribution over five years ago. Will the 10% penalty apply to the distribution because the conversion occurred less than five years ago? I thought the penalty only applied to non-qualified distributions.

Chuck

Answer:
There are two five-year rules for Roth IRA distributions. The first thing to keep in mind is that all of your Roth IRAs are considered one Roth account for distribution purposes. You could have your Roth contributions in one account and your conversion in another account, but for distributions they are treated as one account.

The first funds out of a Roth IRA are considered to come from your contributions, even if you take it from an account that contains no contributions, only converted amounts. Contributions are always distributed tax and penalty free, regardless of any five-year rule or of your age.

Once your contributions are gone, then your distributions are deemed to come from converted amounts, first in, first out. Each conversion is subject to its own five-year holding period. These distributions will be subject to the 10% early distribution penalty if you have not held it for five years and you are not yet 59 ½ on the date of the distribution. In your case, you are now over 59 ½ so the 10% early distribution penalty will not apply (it never applies to any distribution made after the age of 59 ½).

After your contributions and your conversions are totally distributed, then distributions come from earnings. This is where the other five-year rule comes in. In order for distributions of earnings to be tax and penalty free you must have established any Roth IRA more than five years ago and the distribution must be made after age 59 ½ or be due to death, disability of the account owner, or for a first-time home purchase (lifetime cap of $10,000).

You are now in the home-free zone. You have a Roth account established over five years ago and you are over the age of 59 ½. All distributions to you or to your beneficiaries will be tax and penalty free.

3.

Hi Ed and Beverly,

I would like to know if a Roth IRA is exempt from any and all tax liens from state and federal municipalities. I read that any account that has a maximum value of one million or less is also exempt. Can you also let me know if they are excluded from any and all collection agencies?

TKG

Answer:
State law generally provides creditor protection for IRAs. You will have to determine what protection your state provides for your IRA accounts. IRAs have federal protection in bankruptcy. The federal exemption is currently almost $1,200,000 since it is indexed for inflation. Under the federal bankruptcy rules any employer plans rolled over to IRAs are 100% exempt as are SEP and SIMPLE IRAs. The IRS can take (levy) your IRA for unpaid federal taxes.