Backdoor Roth IRA as emergency fund [unique situation, for parents]

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need403bhelp
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Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by need403bhelp » Sat Apr 14, 2018 11:20 am

Thank you all so much for your prior help!

I have previously helped my parents transfer their retirement investments from Voya to Fidelity. Now, my parents asked me to help them find a good alternative for their ~$100,000 emergency fund earning 0.15% in their credit union savings account. The credit union suggested that they put the $100,000 in a 5 year CD, with rates of 2.15%/2.17% and an early withdrawal penalty of 450 (!) days interest.

I believe that my parents are in the new 24% or 26% tax brackets, but will not know for sure until Monday when my father returns from a trip and sends me a copy of their 1040.

My parents do not plan to retire and already have substantial retirement savings with their employer. No pensions.

My thinking was to do the following:
1 - purchase $10k iBonds for both my father and my mother and continue to do so every year. This seems like by far the best and easiest option with respect to both rates and 30 year tax deferral.
2 - my parents currently are not contributing to Roth IRAs (my father has a small one from ~2001 that we are transferring from Voya to Fidelity, my mother doesn't have one). As they are not planning to retire and have substantial retirement savings compared to their annual spending (as far as I understand, anyway), I thought it would be best to use their combined $13,000/year Roth IRA space for a tax-free emergency fund. This may need to be backdoor, depending on my parents' tax return. I was thinking of investing in brokered CDs for this via Fidelity as they are FDIC insured and guarantee principal. Any other thoughts/suggestions re good "emergency fund" type investments in a Roth IRA at Fidelity? (I guess we could use a different provider, but as their retirement funds are now all at Fidelity, it would be easier to keep everything at the same provider.)
3 - for the rest, can just find an online CD via depositaccounts with highest rate?

Now, with respect to #2 above, as my parents are both over age 59/60:
A - IF they can contribute to a (non-backdoor) Roth IRA, do I understand correctly that:
i - BOTH my father and mother can withdraw their PRINCIPAL at any time tax and penalty free AND
ii - my father (who started his first Roth IRA, although at a different institution [Voya vs Fidelity]) in 2001 can withdraw EARNINGS at any time tax and penalty free, whereas my mother (for whom this would be a first Roth IRA) can withdraw EARNINGS penalty free but must pay income tax on any earnings withdrawn over the next 5 years?

B - IF they both contribute to a backdoor Roth IRA:
i - can they withdraw their PRINCIPAL at any time tax and penalty free?
ii - what about their EARNINGS?

Thank you so much!

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FiveK
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Re: Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by FiveK » Sat Apr 14, 2018 6:12 pm

See Roth IRA as an emergency fund for general comments.

For specific questions:
2A) You understand correctly.
2Bi) Yes, the non-deductible tIRA contribution amount converted to a Roth (aka the basis) is neither taxed nor penalized if one gets to that point in the distribution ordering.
2Bii) Earnings are treated the same as for 2A.

See 2017-07-06-Roth-IRA-Distribution-Ordering-Rules.pdf for a tabular summary.

need403bhelp
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Re: Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by need403bhelp » Sat Apr 14, 2018 7:16 pm

FiveK wrote:
Sat Apr 14, 2018 6:12 pm
See Roth IRA as an emergency fund for general comments.

For specific questions:
2A) You understand correctly.
2Bi) Yes, the non-deductible tIRA contribution amount converted to a Roth (aka the basis) is neither taxed nor penalized if one gets to that point in the distribution ordering.
2Bii) Earnings are treated the same as for 2A.

See 2017-07-06-Roth-IRA-Distribution-Ordering-Rules.pdf for a tabular summary.
Thank you so much for your succinct & helpful post.

Re 2Bi), I had another question. With my own backdoor Roths via Vanguard, there is usually a few cent balance that accrues in my traditional IRA before Vanguard allows me to convert it to Roth. It seems that this would go under the "Taxable Conversion Dollars" category in the chart above, and would be subject to a penalty if withdrawn within 5 years. For my mother, who has no prior (non-backdoor) Roth IRA contributions, it seems that any withdrawal from the account would hit this category first. I realize this would be a small amount, but would this mean that any withdrawal for her within 5 years would be subject to a penalty also? Thank you!

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FiveK
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Re: Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by FiveK » Sat Apr 14, 2018 7:29 pm

need403bhelp wrote:
Sat Apr 14, 2018 7:16 pm
Re 2Bi), I had another question. With my own backdoor Roths via Vanguard, there is usually a few cent balance that accrues in my traditional IRA before Vanguard allows me to convert it to Roth. It seems that this would go under the "Taxable Conversion Dollars" category in the chart above, and would be subject to a penalty if withdrawn within 5 years. For my mother, who has no prior (non-backdoor) Roth IRA contributions, it seems that any withdrawal from the account would hit this category first. I realize this would be a small amount, but would this mean that any withdrawal for her within 5 years would be subject to a penalty also? Thank you!
Not all of any withdrawal, but the amount of the withdrawal fitting that specific description. And if there are 49 or fewer of those cents, the amount rounds down to $0 so any percentage tax/penalty on that will also be $0. Keep it under 200 cents and even 22% of that will also round down to $0. :)

need403bhelp
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Re: Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by need403bhelp » Sun Apr 15, 2018 10:43 am

FiveK wrote:
Sat Apr 14, 2018 7:29 pm
need403bhelp wrote:
Sat Apr 14, 2018 7:16 pm
Re 2Bi), I had another question. With my own backdoor Roths via Vanguard, there is usually a few cent balance that accrues in my traditional IRA before Vanguard allows me to convert it to Roth. It seems that this would go under the "Taxable Conversion Dollars" category in the chart above, and would be subject to a penalty if withdrawn within 5 years. For my mother, who has no prior (non-backdoor) Roth IRA contributions, it seems that any withdrawal from the account would hit this category first. I realize this would be a small amount, but would this mean that any withdrawal for her within 5 years would be subject to a penalty also? Thank you!
Not all of any withdrawal, but the amount of the withdrawal fitting that specific description. And if there are 49 or fewer of those cents, the amount rounds down to $0 so any percentage tax/penalty on that will also be $0. Keep it under 200 cents and even 22% of that will also round down to $0. :)
Thanks for the clarification.

Interestingly enough, I just checked on the fairmark article, and I don't think that I have been reading the chart you linked correctly. Specifically, per http://fairmark.com/retirement/roth-acc ... -overview/ (bold added for emphasis):
Taxable portion of a conversion

Applies only when the lifetime total of withdrawals from all Roth IRAs exceeds the lifetime total of regular contributions to Roth IRAs plus the lifetime total of earlier conversions.

- If withdrawn before the first day of the fifth year after the year of the conversion: no tax, but will be subject to 10% early withdrawal penalty if you’re under age 59½ unless an exception applies.
- Beginning on the first day of the fifth year after the year of the conversion can be withdrawn at any time with no tax and no penalty.
If I am reading correctly, then for my mother who is >59.5 years of age, there will be NO penalty and NO tax for the taxable portion of a conversion, EVEN if withdrawn within 5 years of the conversion (from a backdoor Roth contribution that has grown slightly prior to conversion).

On the other hand, your linked table http://retirementlc.com/wp-content/uplo ... -Rules.pdf confused me a little - I guess I don't see a clear definition of "Qualified Distribution" and "Nonqualified Distribution" in the table, nor a definition "Penalty Exception" for a contribution. The paragraph at the top honestly confuses me a little too, as it seems to imply there is always a penalty for converted pre-tax assets that are withdrawn prior to 5 years:
Converted pre-tax assets are distributed tax and penalty free as long as the have been held in the account for five years. If not, a 10 percent would apply to the distribution.
On the other hand, per the fairmark article, there would be NEITHER tax NOR penalty for converted pre-tax assets that are withdrawn prior to 5 years for my mother who is >59.5 years old. Is the fairmark interpretation the correct one?

Thank you again!

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FiveK
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Re: Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by FiveK » Sun Apr 15, 2018 11:37 am

need403bhelp wrote:
Sun Apr 15, 2018 10:43 am
...there would be NEITHER tax NOR penalty for converted pre-tax assets that are withdrawn prior to 5 years for my mother who is >59.5 years old. Is the fairmark interpretation the correct one?
Yes. See also Two 5-Year Rules For Roth IRA Contributions & Conversions:
Thus, for those who are already over age 59 1/2 (or totally disabled), the Roth conversion 5-year rule is essentially a moot point, and only the 5-year rule for contributions remains relevant.

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Artsdoctor
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Re: Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by Artsdoctor » Sun Apr 15, 2018 5:53 pm

The Kitces article will give you all the information you need. However, it makes it easier if you get the terminology straightened out. Your parents are over 59-1/2 so the terminology is relatively moot; but for you, use the term "backdoor Roth conversion" and not "backdoor Roth contribution." In reality, if you're moving taxed money into a traditional IRA and then transferring that money to a Roth, it is a Roth conversion. Once you think of it that way, the "rules" become easier to understand.

need403bhelp
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Re: Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by need403bhelp » Mon Apr 16, 2018 10:02 am

FiveK wrote:
Sun Apr 15, 2018 11:37 am
need403bhelp wrote:
Sun Apr 15, 2018 10:43 am
...there would be NEITHER tax NOR penalty for converted pre-tax assets that are withdrawn prior to 5 years for my mother who is >59.5 years old. Is the fairmark interpretation the correct one?
Yes. See also Two 5-Year Rules For Roth IRA Contributions & Conversions:
Thus, for those who are already over age 59 1/2 (or totally disabled), the Roth conversion 5-year rule is essentially a moot point, and only the 5-year rule for contributions remains relevant.
Thank you so much for the helpful reference and quote from the Kitces articles.

need403bhelp
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Joined: Thu May 28, 2015 6:25 pm

Re: Backdoor Roth IRA as emergency fund [unique situation, for parents]

Post by need403bhelp » Mon Apr 16, 2018 10:03 am

Artsdoctor wrote:
Sun Apr 15, 2018 5:53 pm
The Kitces article will give you all the information you need. However, it makes it easier if you get the terminology straightened out. Your parents are over 59-1/2 so the terminology is relatively moot; but for you, use the term "backdoor Roth conversion" and not "backdoor Roth contribution." In reality, if you're moving taxed money into a traditional IRA and then transferring that money to a Roth, it is a Roth conversion. Once you think of it that way, the "rules" become easier to understand.
Got it. Thank you so much for the clarification re terminology.

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