Slott Report Mailbag: Is a Conversion From an IRA to a Roth IRA Subject to the 10% Penalty?

By Joe Cicchinelli, IRA Technical Expert

Follow Me on Twitter: @JoeCiccEdSlott

This week’s Slott Report Mailbag looks at the 10% early distribution penalty, which is in affect before age 59 1/2 in many cases. We also answer a tricky question about Roth recharacterizations. 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.

Ed,

My daughter is 47 years old. She wants to convert funds from her traditional IRA to fund her Roth IRA each year. Even though she is not age 59 ½, can she move these funds without the 10% penalty since the funds are moving from one IRA to another?

Thanks!

Scott Wheeler

Answer:
A conversion from an IRA to a Roth IRA is taxable, but not subject to the 10% early distribution penalty.

2.

I have always considered my contributions to my Roth IRA as part of my emergency fund, knowing I could take the contributions (but not the earnings) before I reach age 59 ½ with no penalty. I also contribute to a traditional IRA. There was one year when my income unexpectedly jumped up above the level allowed for a tax-deductible IRA, but I didn’t realize I wasn’t eligible until months after I made my contribution. Come April when I did my taxes I had this contribution re-characterized as a Roth IRA and paid taxes on it. My question is this: can the money I re-characterized be included as the portion of my Roth IRA, which can be taken out before 59 1/2 without penalty?

Answer:
Yes. Your recharacterized IRA contribution is treated as a Roth IRA contribution that can be withdrawn tax-and-penalty free at any time.

3.

I made three conversions in 2010. I know that I will be able to make qualified withdrawals on January 2, 2015. I also made a conversion on 1/3/2012. Must this conversion be governed by its own 5-year rule, meaning, qualified withdrawals will begin on 1/3/2017?

Thanks.

Answer:
Assuming you are now age 59 ½ or older, there is no separate 5-year clock for purposes of the 10% penalty on the 2012 conversion because that penalty doesn’t apply any longer. But, if you’re under age 59 ½, the 2012 has its own separate 5-year clock with respect to the 10% penalty. With respect to a qualified withdrawal of interest, there is only one 5-year clock that expires on 1-1-15. All of your future Roth IRA withdrawals will be qualified (tax-free) from then on.