Slott Report Mailbag: How Do These Roth IRA 5-Year Rules Work?

By Joe Cicchinelli, IRA Technical Expert

Follow Me on Twitter: @JoeCiccEdSlott

The Slott Report Mailbag is full of inquiries on one of our most discussed topics, the Roth IRA 5-year rules, as well as a question that came from our Wednesday article on where you report your 2013 Roth IRA contributions on your tax return (hint: nowhere!).  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.

I am 66 years old and have held both my Traditional IRA and Roth IRA more than five years. I am currently taking distributions from my Traditional IRA each month for retirement living expenses and associated income taxes.

Can I make a Roth IRA conversion each January for my projected annual expenses plus contingencies, then withdraw each month that year from the Roth for living expenses and conversion taxes due?

I’m confused about the five-year holding period between each Roth conversion and its withdrawal. I am also trying to slowly draw down my Traditional IRA through conversions to reduce the RMD (required minimum distributions) impact at 70 1/2.

Thanks,
Byron

Answer:
The five-year rule for penalty-free distributions of conversion funds does not apply to you because you are over age 59 ½. It only applies when conversion funds are withdrawn within the first five years and you’re under age 59 ½ at the time. The Roth IRA 5-year rules can be confusing, and we have written extensively on the topic in this collection of articles.

2.

I plan on converting money each year from a Traditional IRA to a Roth IRA and would like to be sure to keep my income in the 15% tax bracket. I understand that in calculating my income for the year, I must include the amount I am converting to a Roth. Which income line (number) on Form 1040 is used by the IRS to determine tax bracket?

Thank you!

Answer:
Generally, the tax cost of a conversion is determined by your taxable income, which is found on line 43 of the 2013 IRS Form 1040. You can use tax software to estimate the effect that a conversion will have on your taxable income. Also, if you later decide that you’ve converted too much, you can always undo (recharacterize) some or all of the conversion by October 15 of the following year.

3.

I have a question regarding Roth IRA’s per your Wednesday article on reporting Roth IRA contributions on your tax return. If there is no “record” of Roth IRA contributions on your tax return, then who is to stop an individual who is technically phased out from contributing into a Roth IRA? How would the IRS ever catch wind of this?

Answer:
The IRS will receive a copy of Form 5498 from the IRA custodian that shows the amount of the Roth IRA contribution for the year. The IRS can then check the person’s Form 1040 to see if their income was too high to make a Roth IRA contribution. Making a Roth IRA contribution when your income is too high means that the Roth has an excess contribution in it, which is subject to a 6% penalty each year until it’s corrected. You report the penalty on IRS Form 5329. When that form is not filed, the statute of limitations on the penalty does not start to run.