5-year rule for Roth distributions?

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5-year rule for Roth distributions?

Postby Lbill » Thu Sep 17, 2009 12:28 pm

Can someone clarify the 5-year rule for taking Roth distributions? I thought that the rule applies to everyone - that is, you cannot take withdrawals of principal for 5 years after that principal has been contributed to a Roth. However, I recently ran across a commentary somewhere that the rule applies to those who are younger than 59 1/2, but does not apply to older investors. Which is correct?
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Postby HueyLD » Thu Sep 17, 2009 1:22 pm

There are no exceptions to the 5-year rules. Some financial writers are simply not diligent enough to write articles on Roth.
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Postby R-Man » Thu Sep 17, 2009 1:34 pm

One point I am still confused on is the timing of the 5 years for a withdrawal. Does the 5 years apply only to the original contribution amount or does each contribution or regular IRA conversion have a separate 5 year waiting period before those funds can be withdrawn? :?:
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Postby retiredjg » Thu Sep 17, 2009 1:36 pm

HueyLD wrote:There are no exceptions to the 5-year rules. Some financial writers are simply not diligent enough to write articles on Roth.

HueyLD, I'm sure you are correct because you tend to know these things. However, your answer doesn't really tell us much.

There may be no exceptions to the 5 year rule, but I believe there is much confusion about what the 5 year rule covers. For example, I believe the OP's original statement of "that is, you cannot take withdrawals of principal for 5 years after that principal has been contributed to a Roth." is an incorrect statement.

Maybe you could comment on what the 5 year rule does cover, please.
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Postby Lbill » Thu Sep 17, 2009 1:36 pm

Below, I've copied a query and answer from Ed Slott's IRA forum that applies to my situation:
Question: I currently have had a Roth at Vanguard for over 5 years and am over 59.5 years old.

If I roll do a Roth Conversion at Fidelity and open a Roth account at Fidelity will it have to be open 5 years before I can do tax free withdrawals or will the 5 year "clock" that has already expired at Vanguard cover the Fidelity account?

Answer: Your Vanguard time will cover all future IRA accounts since the 5 year holding period for all your Roths to be qualified starts with the year of your first Roth contribution of any type (regular or conversion).

The "other" 5 year holding period for each conversion is also no longer a factor for you since you are over 59.5.

You are now in a position where any part of any of your Roth accounts can be distributed tax and penalty free.


I conclude that, if you are at least 59 1/2 and have opened any Roth at least 5 years ago, then all future contributions or conversions to Roth IRAs, either the original Roth or new Roths, are not subject to the 5-year withdrawal penalty of 10%. I was under the impression that 5-year clocks ran separately for each Roth contribution from the time it was made.
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Re: 5-year rule for Roth distributions?

Postby BruceM » Thu Sep 17, 2009 1:41 pm

Lbill wrote:Can someone clarify the 5-year rule for taking Roth distributions? I thought that the rule applies to everyone - that is, you cannot take withdrawals of principal for 5 years after that principal has been contributed to a Roth. However, I recently ran across a commentary somewhere that the rule applies to those who are younger than 59 1/2, but does not apply to older investors. Which is correct?


You may withdraw the 'principal', or the direct contribution amounts at any age, in any amount (up to the total of past direct contributions) for any purpose. There is no penalty or tax.

After withdrawing all of the basis (principal), withdrawal of earnings will be includable as ordinary income and subject to a 10% early withdrawal penalty, unless the Roth holder has held a Roth for at least 5 years. and

1. is at least 59.5 or
2. is using the withdrawl to purchase a 'first time' home for him/herself or an immediated family member or
3. is fully disabled or
4. is the beneficiary of the mandatory distributions from the decedent's Roth

If the contributions are from a TIRA conversion, the same exceptions apply, except that the conversion amount that represents the pretax part of the conversion will be subject to a 10% early elective withdrawal penalty until the conversion has been held at least 5 years or the individual attains age 59.5, whichever comes sooner.

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Postby aab » Thu Sep 17, 2009 1:49 pm

This IRS chart helped me when I was trying to make sense of the whole thing.

Image

The original link for the chart is here:

http://www.irs.gov/publications/p590/15160x04.html
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Roth IRA Rules From Vanguard

Postby BillRogers » Thu Sep 17, 2009 1:59 pm

Taxes on withdrawals
Special taxation rules apply to withdrawals of contributions and earnings.

Roth IRA
None.

Taxes on earnings
Age 59½ or older: None if you’ve held the account five years or more; ordinary federal income tax if you've held the account less than five years.
Under age 59½: Ordinary federal income tax if you've held the account for five years or more, unless the distribution is due to your death or disability or for a first-time home purchase ($10,000 lifetime maximum); ordinary federal income tax if you've held the account for less than five years.
State taxes may apply.

Penalty for early withdrawals

From contributions: None.
From earnings: No penalty if you're age 59½ or older; 10% federal penalty tax if you're under age 59½ unless an exception applies

Bill Rogers

[/b]
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Postby malloc » Thu Sep 17, 2009 2:45 pm

Do I understand this correctly?

My wife is changing jobs and has been told that she has the opportunity to open a Roth with at a token amount of money to start the 5 year clock. Then 4 or 5 years later money could be rolled into the Roth (paying applicable taxes at the time) if it then seemed to be a good idea?

Can this really satisfy the 5 year rule?
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Postby DSInvestor » Thu Sep 17, 2009 3:00 pm

Here's a fairmark.com page on ROTH-IRA distributions:
http://www.fairmark.com/rothira/distrib.htm
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Postby Lbill » Thu Sep 17, 2009 3:12 pm

I dunno. The Fairmark stuff reads like most of the other stuff I've seen including what the IRS prints - I can't understand half of what is being said. That's why I need someone to explain it to me. :confused
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Postby retiredjg » Thu Sep 17, 2009 3:22 pm

malloc wrote:My wife is changing jobs and has been told that she has the opportunity to open a Roth with at a token amount of money to start the 5 year clock. Then 4 or 5 years later money could be rolled into the Roth (paying applicable taxes at the time) if it then seemed to be a good idea?

Can this really satisfy the 5 year rule?

Your wife's Roth IRA has nothing to do with the plan offered at her job. Is she talking about what people refer to as Roth 401(k)? It's a different subject entirely from what is being discussed here. Rules might be the same though.
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Changing jobs

Postby Taylor Larimore » Thu Sep 17, 2009 3:25 pm

malloc wrote:Do I understand this correctly?

My wife is changing jobs and has been told that she has the opportunity to open a Roth with at a token amount of money to start the 5 year clock. Then 4 or 5 years later money could be rolled into the Roth (paying applicable taxes at the time) if it then seemed to be a good idea?


Hi malloc:

Not an answer to your question, but if your wife has a 40lK or similar plan, she should probably rollover her current plan into an IRA (Roth or Traditional) instead of rolling over into a new plan with a new employeer.

Nearly always, an IRA has lower costs, a greater selection of funds, and more flexibility than an employeer plan.
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Postby malloc » Thu Sep 17, 2009 3:35 pm

Thank you Taylor

She is enjoying not knowing just what she will do next
Retirement is not out of the question
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Postby fishnskiguy » Thu Sep 17, 2009 4:11 pm

Here is the simple answer to the original question.

You can take money out of a Roth IRA at any time, any age, with no tax or penalties up to the total of all contributions.

Example. You open a Roth at age 30. Total contributions over the years total $50K. At age 45 the Roth is worth $90K. You can take out up to $50K any time, no tax, no penalties. This makes sense since you already paid tax on that amount.

After that, you must wait until age 59 1/2 and have had the IRA at least five years ( you have in my example) to avoid penalties and tax on any further withdrawal.

Another example. You open a Roth IRA at age 58 and contribute $5000. Next year it is worth $5500. You can take out up to $5000 any time, any age without penalty or tax. You must wait until age 63 (five years) to take out any more without penalties and tax.

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Postby Mitchell777 » Thu Sep 17, 2009 6:20 pm

What happens if you convert a traditional IRA to a Roth IRA and then die before the 5 year period? If there a financial penalty or do your heirs need to wait 5 years from the day of initial conversion?
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Postby GG » Thu Sep 17, 2009 6:34 pm

fishnskiguy wrote:Here is the simple answer to the original question.

You can take money out of a Roth IRA at any time, any age, with no tax or penalties up to the total of all contributions.

Example. You open a Roth at age 30. Total contributions over the years total $50K. At age 45 the Roth is worth $90K. You can take out up to $50K any time, no tax, no penalties. This makes sense since you already paid tax on that amount.

After that, you must wait until age 59 1/2 and have had the IRA at least five years ( you have in my example) to avoid penalties and tax on any further withdrawal.

Another example. You open a Roth IRA at age 58 and contribute $5000. Next year it is worth $5500. You can take out up to $5000 any time, any age without penalty or tax. You must wait until age 63 (five years) to take out any more without penalties and tax.

Chris


Thank God someone posted the "right" answer! I was reading the post wondering how many posts it was going to take.
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Postby retiredjg » Thu Sep 17, 2009 6:41 pm

I think there have been at least a couple of right answers, but some of the answers, even the right ones, don't seem to take into account Roth conversions , only contributions. Or maybe I''m missing something.

However, I believe there is a new 5 year clock that starts with each conversion. I'm real unclear how age 59.5 fits in with that though.
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Postby DSInvestor » Thu Sep 17, 2009 6:50 pm

retiredjg wrote:I think there have been at least a couple of right answers, but some of the answers, even the right ones, don't seem to take into account Roth conversions , only contributions. Or maybe I''m missing something.

However, I believe there is a new 5 year clock that starts with each conversion. I'm real unclear how age 59.5 fits in with that though.


Here's a fairmark.com page on "Distributions after a ROTH-IRA Conversion"
http://www.fairmark.com/rothira/rolldist.htm
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Postby OAG » Thu Sep 17, 2009 7:02 pm

Publication 590 at the IRS Site starting in page 67 should answer the question(s). Search on Pub 590 at www.irs.gov.
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Postby minesweep » Thu Sep 17, 2009 7:07 pm

Mitchell777 wrote:What happens if you convert a traditional IRA to a Roth IRA and then die before the 5 year period? If there a financial penalty or do your heirs need to wait 5 years from the day of initial conversion?

Exceptions. You may not have to pay the 10% additional tax in the following situations.

You are the beneficiary of a deceased IRA owner.

IRS Publication 590 - page 67

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Postby HueyLD » Thu Sep 17, 2009 7:32 pm

retiredjg wrote:I think there have been at least a couple of right answers, but some of the answers, even the right ones, don't seem to take into account Roth conversions , only contributions. Or maybe I''m missing something.

However, I believe there is a new 5 year clock that starts with each conversion. I'm real unclear how age 59.5 fits in with that though.

Hi jg,

The 59 ½ rule is there to prevent taxpayers from circumventing the 10% penalty rule. As an example:

(1) A 50-year old guy withdraws $100,000 from his T-IRA (100% pretax money). If none of the exceptions to the penalty applies, he will incur a regular tax liability on the $100k and a 10% penalty on the $100k.

(2) The same person converts $100,000 from his pretax T-IRA to Roth and pays taxes on the conversion. He then withdraws $100k from his Roth. It would be a gigantic tax loophole if he could do so w/o having to pay the 10% penalty.

I thank my college professors for teaching me to understand the reasons for our tax regulations. In many instances (not all of course), there are good reasons behind all those special rulings.
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Postby Lbill » Thu Sep 17, 2009 7:47 pm

However, I believe there is a new 5 year clock that starts with each conversion. I'm real unclear how age 59.5 fits in with that though

See my previous post of the transcript from Ed Slott's IRA forum. According to this, there is not a new 5-year clock started with each conversion - there is only one clock that starts from the date you first established a Roth IRA. If 5 years have elapsed since this date, you can withdraw earnings penalty-free if you meet one of the following conditions:
- you are at least 59 1/2
- you are withdrawing for a first home
- you are disabled
- you are dead

Therefore, if you are at least 59 1/2 and you have owned a funded Roth for at least 5 years, no future conversions are subject to the 5-year penalty. You can convert as often as you desire, to existing or new Roths and withdraw any converted funds as well as earnings, at any time following the conversion. At least that's the way I read it.
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Postby GG » Thu Sep 17, 2009 8:10 pm

I would just like to congratulate the forum for making a simple post question into a quagmire of confusion with multiple answers. Of course the inability to know "exactly" the right response in the OPs question is a problem, but the overkill in this post should be on wiki do/dont list. These rules are pretty simple.
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Postby HueyLD » Thu Sep 17, 2009 8:44 pm

Lbill wrote:See my previous post of the transcript from Ed Slott's IRA forum. According to this, there is not a new 5-year clock started with each conversion - there is only one clock that starts from the date you first established a Roth IRA. If 5 years have elapsed since this date, you can withdraw earnings penalty-free if you meet one of the following conditions:
- you are at least 59 1/2
- you are withdrawing for a first home
- you are disabled
- you are dead

Therefore, if you are at least 59 1/2 and you have owned a funded Roth for at least 5 years, no future conversions are subject to the 5-year penalty. You can convert as often as you desire, to existing or new Roths and withdraw any converted funds as well as earnings, at any time following the conversion. At least that's the way I read it.

Hi Lbill,

Repeat after me. There is a separate 5-year holding period for each conversion. I would normally refer someone to an IRS pub., but I won't ask you to because you said you had trouble understanding the mumbo jumbo in tax pubs.

However, do keep in mind that once you paid taxes on the conversion, the only tax you will have to pay in the future (assuming you are over 59 1/2) is the earnings since conversion. In other words, you only pay taxes once.

Good luck and best regards.
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One last (hopefully) question

Postby gotherelate » Thu Sep 17, 2009 9:11 pm

Are earnings on converted amounts taxable on withdrawal within the five-year holding period for that conversion if the taxpayer is over 59 1/2 at time of withdrawal?

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Postby Lbill » Thu Sep 17, 2009 9:14 pm

The Ed Slott forum expert said:
Your Vanguard time will cover all future IRA accounts since the 5 year holding period for all your Roths to be qualified starts with the year of your first Roth contribution of any type (regular or conversion).

The "other" 5 year holding period for each conversion is also no longer a factor for you since you are over 59.5.

But HueyLD said:
Repeat after me. There is a separate 5-year holding period for each conversion.

Huey's statement is the first clear and unequivocal statement I've seen from any source - it is completely non-ambiguous. However, it appears to me to be discrepant from the IRA expert's comments, as I understand them. Somebody's wrong - I appeal to a higher authority. Perhaps that IRS document would help (but I doubt it). :confused
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Postby HueyLD » Thu Sep 17, 2009 9:34 pm

O.K., Lbill. Here is a quote from the Pub 590.
Distributions of conversion and certain rollover contributions within 5-year period.

If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income. A separate 5-year period applies to each conversion and rollover. See Ordering Rules for Distributions , later, to determine the amount, if any, of the distribution that is attributable to the part of the conversion or rollover contribution that you had to include in income.
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Re: One last (hopefully) question

Postby HueyLD » Thu Sep 17, 2009 9:37 pm

gotherelate wrote:Are earnings on converted amounts taxable on withdrawal within the five-year holding period for that conversion if the taxpayer is over 59 1/2 at time of withdrawal?

Yes, sir. They are known as nonqualified distributions.
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Postby Lbill » Thu Sep 17, 2009 9:42 pm

A Google search turned up the following:
Taxation and Penalties for Roth IRA Distributions

Qualified distributions from a Roth IRA are not includible in income or subject to the 10% early withdrawal penalty. A qualified distribution is a distribution to an owner after the owner has reached age 59½ (or who is disabled, a first-time home buyer, or in the case of a beneficiary of the estate, death) and the Roth IRA has been funded for a 5-year period, beginning on the first day of the tax year in which a conversion from a regular IRA is made or for which a contribution is made, and ending with the last day of the 5th year from the beginning year . If the distribution is made to a beneficiary of the estate of the owner, the period held by the decedent is included in the period held by the beneficiary to determine whether the 5-year period is satisfied (408A(d)(2)(A) and Reg. §1.408A-6, Q&A-1(b)).

A withdrawal from a Roth IRA is treated as made first from direct contributions to the Roth IRA, then from conversion contributions (first-in first-out, or FIFO, basis), and then from earnings in the Roth IRA in the order specified below under Nonqualified Distributions.

Holding Periods. Each Roth owner has only one 5-year period for purposes of determining qualified distributions (Reg. §1.408A-6, Q&A-2). An individual's 5-year period begins with the first tax year for which a contribution is made for any Roth IRA (408A(d)(2)(B))). A conversion of a regular IRA into a Roth IRA after the five-year period has begun will not start the running of a new 5-year period for purposes of determining whether the distribution is a qualified distribution (S Rept No 105-174 (P.L. 105-206, i.e, the '98 Act). Thus, once a holding period is begun, either by a conversion or direct contribution, any distribution, even one from contributions or conversions made before the end of the 5-year period, will be excludable from income as a qualified distribution if the taxpayer is age 59½ or otherwise satisfies one of the early distribution conditions (disability, death, or qualified special purposes).

Furthermore:
Proposed regulations issued in September, 1998 provide detailed thinking of the IRS on Roth IRAs. These are published as Proposed Regulations Sections 1.408A-0 through 1.408A-9. Although proposed regulations do not have the force of the law detailed below, they indicate how the IRS will rule on private letter rulings or on audit.
- Multiple Roth IRAs are treated as one Roth IRA for purposes of applying the rules for holding period, withdrawal penalty (408A(d)(4)).

http://www.kaspercpa.com/rothirataxation.htm

Well, at least one CPA seems to agree with Slott's expert. But, then again, I probably am misunderstanding it. Let's take a vote. :roll:
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Re: One last (hopefully) question

Postby gotherelate » Thu Sep 17, 2009 9:43 pm

HueyLD wrote:
gotherelate wrote:Are earnings on converted amounts taxable on withdrawal within the five-year holding period for that conversion if the taxpayer is over 59 1/2 at time of withdrawal?

Yes, sir. They are known as nonqualified distributions.


But the converted amounts themselves are not taxable in the above scenario, right? Presumably because they've already been taxed.

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Re: One last (hopefully) question

Postby HueyLD » Thu Sep 17, 2009 9:44 pm

gotherelate wrote:
HueyLD wrote:
gotherelate wrote:Are earnings on converted amounts taxable on withdrawal within the five-year holding period for that conversion if the taxpayer is over 59 1/2 at time of withdrawal?

Yes, sir. They are known as nonqualified distributions.


But the converted amounts themselves are not taxable in the above scenario, right? Presumably because they've already been taxed.

-Grandpa

Yes.
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Postby HueyLD » Thu Sep 17, 2009 9:55 pm

Lbill,

Let me quote a section from page 67 of the pub. 590.
For example, if a calendar-year taxpayer makes a conversion contribution on February 25, 2008, and makes a regular contribution for 2007 on the same date, the 5-year period for the conversion begins January 1, 2008, while the 5-year period for the regular contribution begins on January 1, 2007.

I would take the IRS' interpretation over a CPA's interpretation. Keep in mind that I am a big fan of the accounting profession.
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Postby On Approach » Thu Sep 17, 2009 9:57 pm

Nearly always, an IRA has lower costs, a greater selection of funds, and more flexibility than an employeer plan.


As Taylor pointed out, nearly always. Lower costs can be had in an employer plan. Examples that come to mind are the TSP and the UC Retirement Savings Plan.
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Postby On Approach » Thu Sep 17, 2009 10:02 pm

You must wait until age 63 (five years) to take out any more without penalties and tax.


No penalties under any circumstances if you're over 59-1/2.
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Postby Lbill » Thu Sep 17, 2009 10:57 pm

HueyLD - IRS Pub 590 seems clear enough to me. I don't know how to reconcile it with the commentary of the CPA and the Ed Slott "expert." But, you can see why this stuff seems so murky to me. There are subtleties in the wording from most of these sources that are not entirely clear, or are misleading. Even the nice IRS flowchart isn't completely clear with the wording "Has it been at least 5 years since you first set up and contributed to a Roth IRA?" Does that mean "any" Roth IRA or is it referring to each specific IRA? One has to parse the meaning very carefully. So far, Pub 590 seems the clearest, but I'm still not 100% satisfied I've heard the last word. And what about the situation where someone has done successive annual conversions to the same Roth IRA? If each conversion has a separate clock, then you have to disentangle the earnings attributable to each separate conversion to figure if and how much the 10% early distribution tax might be on distributions. I can't believe the IRS intended this but - hey - we're talking about the government here aren't we?
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Postby BruceM » Thu Sep 17, 2009 11:39 pm

HueyLD wrote: Repeat after me. There is a separate 5-year holding period for each conversion. I would normally refer someone to an IRS pub., but I won't ask you to because you said you had trouble understanding the mumbo jumbo in tax pubs.

However, do keep in mind that once you paid taxes on the conversion, the only tax you will have to pay in the future (assuming you are over 59 1/2) is the earnings since conversion. In other words, you only pay taxes once.

Good luck and best regards.


Unless the individual attains age 59.5 prior to 5 years following the conversion or the individual is already 59.5 when he/she does the conversion. So if I'm age 62 and do a Roth conversion yet I have not held a Roth for at least 5 years, I can withdraw the conversion immediately as basis.

Put the following to memory:

A qualified Roth withdrawal occurs when one attains age 59.5 AND has held a Roth for at least 5 years, whichever comes LATER

A TIRA to Roth IRA conversion may be withdrawn without penalty (or tax) when the conversion is held at least 5 years OR the individual attains age 59.5, whichever comes SOONER

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Postby Lbill » Fri Sep 18, 2009 9:03 am

Yes, HueyLD is correct re: there are separate 5-year holding periods for different Roth conversions. However, BruceM is correct that the 5-year holding period requirement is null and void when you reach 59 1/2 years of age. Here is the relevant portion of IRS Pub 590:
Other early distributions. Unless one of the exceptions listed below applies, you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions.

Exceptions. You may not have to pay the 10% additional tax in the following situations.
- you have reached age 59 1/2


Bottom line: for those of us who have reached 59 1/2, no 5-year clocks to deal with when taking our Roth distributions. :D
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Postby GG » Fri Sep 18, 2009 10:35 am

On Approach wrote:
You must wait until age 63 (five years) to take out any more without penalties and tax.


No penalties under any circumstances if you're over 59-1/2.


Wrong!!!
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Postby GG » Fri Sep 18, 2009 10:48 am

Lbill wrote:Yes, HueyLD is correct re: there are separate 5-year holding periods for different Roth conversions. However, BruceM is correct that the 5-year holding period requirement is null and void when you reach 59 1/2 years of age. Here is the relevant portion of IRS Pub 590:
Other early distributions. Unless one of the exceptions listed below applies, you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions.

Exceptions. You may not have to pay the 10% additional tax in the following situations.
- you have reached age 59 1/2


Bottom line: for those of us who have reached 59 1/2, no 5-year clocks to deal with when taking our Roth distributions. :D


Also wrong!! Everyone has a 5 year clock regardless of age on contributions. Your quote only applies to conversions.
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Postby Lbill » Fri Sep 18, 2009 11:44 am

GG - To put it all together, as I see it: Qualified distributions have to be held for at least 5 years and the recipient must be at least 59 1/2 (or disabled, dead, or a first-time homebuyer). All qualified distributions do not incur the 10% additional tax. If you do not meet the requirements for a qualified distribution, you will incur the 10% additional tax. However, there are certain exceptions in the case of receiving distributions from Roth conversions or rollovers from traditional IRAs, etc. (not regular Roth contributions, as you point out). One of the exceptions is if the recipient is at least 59 1/2. In that case, distributions of funds in a Roth that are attributable to conversions or rollovers do not incur the 10% additional tax. This provision appears to be intended to prevent people from taking early distributions from their traditional IRA, penalty-free, by first converting the funds to a Roth and then taking a Roth distribution. If you are over 59 1/2, the IRS is cool with you on this matter, so the 5-year holding period becomes null. I believe you are correct, however, that it does not become null in the case of taking Roth distributions that are attributable to regular contributions instead of conversions or rollovers. An important distinction. In my case, I was interested in Roth conversions I've made - rather than regular contributions.
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Postby On Approach » Fri Sep 18, 2009 10:38 pm

No penalties under any circumstances if you're over 59-1/2.


As I said earlier - no penalties under any circumstances if you're over 59-1/2. The 10% penalty goes away.
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Postby GG » Fri Sep 18, 2009 11:08 pm

On Approach wrote:
No penalties under any circumstances if you're over 59-1/2.


As I said earlier - no penalties under any circumstances if you're over 59-1/2. The 10% penalty goes away.


Wrong!!!!!
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Postby Lbill » Sat Sep 19, 2009 11:34 am

I don't want to speak for GG, but I believe he is reiterating that reaching 59 1/2 exempts you from the 10% penalty for early distributions (i.e., distributions taken before you have met the 5-year holding requirement) - but only for funds in the Roth attributable to a conversion or rollover from a non-Roth account. If the funds in the Roth are attributable to contributions, you still incur the penalty unless you have met the 5-year holding rule for those funds. So "no penalty under any circumstances" is incorrect. This 5-year rule applies to each Roth contribution, conversion, or rollover separately. In other words, there are multiple 5-year clocks running.

To make matters sufficiently confusing, there is a second 5-year rule which determines the taxation of earnings accrued in the Roth IRA. Distributed earnings are subject to income tax until 5 years have expired since you first put money into a Roth IRA. This is a one-time requirement (i.e., there is one clock running). For example, if I put money into a Roth (or multiple Roths) every year beginning in August 2004, as of August 2009 I met the 5-year holding requirement for earnings to be withdrawn tax-free from any of my Roth accounts (however I still might incur the 10% penalty on withdrawals, as explained above). When you withdraw money from a Roth, the IRS applies a first-in, first-out rule: your principal (which is not taxable) is deemed to come out before earnings (which are taxable unless you've met the 5-years since first Roth rule).

I'm not a tax expert or authority - simply putting together the information I've managed to glean from several sources. You should carefully read IRS Pub 590 and/or consult your tax advisor to verify the above before deciding to take any distributions from your Roths. I believe the only time you are unequivocally free and clear of both penalties and tax, regardless of the source of the Roth funds, is if the distributions are qualified distributions. In order to be qualified distributions, you must (1) have held the specific Roth funds involved for at least 5 years and (2) be at least 59 1/2, disabled, dead, or a first time homebuyer.
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Ridiculous tax rules

Postby Taylor Larimore » Sat Sep 19, 2009 12:27 pm

Bogleheads:

This Conversation exemplifies the absurdity of just one of our convoluted IRS Regulations--which now number over 60,000 pages of fine print.

It's a shame.
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Postby Lbill » Sat Sep 19, 2009 12:36 pm

Taylor - I COULD NOT AGREE MORE! This has consumed far more of my time than it should have and I'm still not sure that I have the answers I sought, or even whether to trust the answers I'd get from a tax advisor on the matter. Most of the explanations I ran across on the web, whatever the source, seemed incorrect, incomplete, incoherent, or ambiguous. :x :x :x
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Postby marana » Sat Sep 19, 2009 3:24 pm

Taylor,

Another takeaway from this thread is that one should not rely on results from a google search to answer complex tax questions.
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Postby kaneohe » Sat Sep 19, 2009 7:47 pm

Lbill wrote: If the funds in the Roth are attributable to contributions, you still incur the penalty unless you have met the 5-year holding rule for those funds.

I believe the only time you are unequivocally free and clear of both penalties and tax, regardless of the source of the Roth funds, is if the distributions are qualified distributions. In order to be qualified distributions, you must (1) have held the specific Roth funds involved for at least 5 years and (2) be at least 59 1/2, disabled, dead, or a first time homebuyer.


Lbill.......this conclusion about contributions seems to be in direct conflict w/ this from the Fairmark site:

http://www.fairmark.com/rothira/taxfree.htm
which I read to mean that withdrawing contributions are tax/penalty free in all circumstances.

I confess to having attempted reading pub 590 w/o finding anything to confirm the fairmark conclusion so logically you would think that I should support your position, yet my seat-of-the-pants judgments suggests that I should be not put too much money betting against Kaye Thomas of fairmark.com.

edit: re-read Pub 590. Perhaps the justification for fairmark's conclusion comes, not from simply the words "penalty on taxable part of distribution" but in combination w/ the worksheet of p.70 of Pub 590 to calculate the taxable portion of distribution in accordance w/ the "ordering" rules:

http://www.irs.gov/pub/irs-pdf/p590.pdf

If the worksheet shows 0 taxable amount, then no penalty even though it was a potential problem not otherwise excluded.
Last edited by kaneohe on Sun Sep 20, 2009 4:24 am, edited 1 time in total.
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Re: 5-year rule for Roth distributions?

Postby Taylor Larimore » Sat Sep 19, 2009 8:18 pm

Lbill wrote:Can someone clarify the 5-year rule for taking Roth distributions? I thought that the rule applies to everyone - that is, you cannot take withdrawals of principal for 5 years after that principal has been contributed to a Roth. However, I recently ran across a commentary somewhere that the rule applies to those who are younger than 59 1/2, but does not apply to older investors. Which is correct?


LBill:

I copied this for you from today's Wall Street Journal:

When you convert assets to a Roth IRA from other IRAs or retirement plans, you have to hold those assets in a Roth for five years or until you turn 59 1/2 years old, whichever comes first, to make penalty-free withdrawals of your converted amounts. Each conversion has its own five-year clock.

But if you're already 59 1/2 and you convert traditional IRA assets to a Roth, you can withdraw the assets you convert at any time without worrying about a five-year deadline or penalties. It's a different story with any earnings on those assets: You have to have held a Roth account for five years to withdraw any earnings tax-free.

But you generally don't need to worry about separating the converted funds from the earnings, since the withdrawal rules for Roth IRAs say that any distributions first come from contributions, then from conversions, and finally from earnings, Mr. Slott says.
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Postby cherijoh » Sat Sep 19, 2009 9:37 pm

malloc wrote:Do I understand this correctly?

My wife is changing jobs and has been told that she has the opportunity to open a Roth with at a token amount of money to start the 5 year clock. Then 4 or 5 years later money could be rolled into the Roth (paying applicable taxes at the time) if it then seemed to be a good idea?

Can this really satisfy the 5 year rule?


Not for the rollover amounts. When you take money from a 401-k or TIRA and "roll it over" in a Roth IRA it is considered a conversion and a new 5-yr clock starts on the converted amount. But you can start a Roth with a token amount have the 5-yr clock for annual contributions.

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