5 year clock for multiple Roth IRAs

Submitted by Larry Carr on Tue, 2009-09-15 16:17

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?

Thanks



Submitted by Bill Lohss on Fri, 2009-09-18 02:41

Alan – can I ask you to further clarify your response. It states clearly in IRS Pub. 590 that the 5 year period used to determine whether the 10% early distribution tax applies to Roth distributions is separately determined for each conversion and rollover (p. 67). This says to me that you do in fact have multiple 5-year clocks running for each separate conversion to the same or different Roth IRAs, based on the respective date when each conversion was done. For example, if I did a TIRA to Roth conversion in 2005, all amounts including earnings could be withdrawn tax-free in 2010 if I am at least 59 1/2. If I did another conversion in 2006, any earnings that are distributed before 2011 would be subject to the 10% early distribution tax. If I have done successive annual conversions to the same Roth IRA this could really get messy when I want to take distributions. To be safe, I’d need to wait until 5 years after the most recent conversion. Thanks.



Submitted by Alan Spross on Tue, 2009-09-15 17:21

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.



Submitted by Alan Spross on Fri, 2009-09-18 04:08

I don’t think that you read far enough on p 67. Note that the second column indicates that “unless one of the exceptions listed later applies” the early withdrawal penalty would be due. The first of those many exceptions is turning 59.5. The original poster had passed that age, so he would not have to worry about conversion holding periods any longer.

It is correct that there are separate 5 year holding periods for conversions done in different years, so you need to be aware of that, but ONLY until you reach 59.5. Reaching 59.5 wipes out all the holding periods for conversions that may have been in place the day prior to turning 59.5.



Submitted by Bill Lohss on Fri, 2009-09-18 12:40

Alan – you stated:
“Reaching 59.5 wipes out all the holding periods for conversions that may have been in place the day prior to turning 59.5.” In my case I’m concerned about separate conversions that I have been doing annually since I retired at age 62. Am I assuming correctly that the 5-year holding period for these Roth conversions doesn’t apply at all in my case? That is, conversions I did in 2006, 2007, 2008 and 2009 all have NO 5-year holding requirement before any and all monies (including earnings) can be distributed tax-free?



Submitted by Alan Spross on Sat, 2009-09-19 01:51

Yes, that is correct. Age 59.5 ends the penalty no matter when you did the actual conversion. For example, if you converted at 58, you are subject to the penalty for 1.5 years and then you are exempt.

As far as taxation on earnings, that depends on a different 5 year requirement. This one starts with the year of your first Roth contribution. If it was prior to 2005, then you have also met that requirement. However, since your earnings come out last after all contributions, it is most likely that you would reach the 5 year requirement before you reached your earnings.



Submitted by Janine Janine on Fri, 2009-09-25 01:12

What if someone inherits a Roth IRA that is less than 5 years old? The beneficiary would have to take RMD by 12/31 of the year following the death, but would he/she have to pay income taxes?

Thank you.



Submitted by Alan Spross on Fri, 2009-09-25 02:37

Highly unlikely that there would be taxes for a distribution as small as an RMD. The inherited Roth attains qualification after 5 years starting with the year the owner first contributed, and the beneficiary’s interest period is added to the owner’s period of ownership. Since prior to the Roth becoming qualified, regular and conversion contributions come out first tax free, it is very unlikely that an RMD could reach earnings before the 5 year qualification period was attained.

In order for any amount to be taxable to the beneficiary, the beneficiary would probably have to take out far more than the RMD, and in addition, the owner would have had to remove most of their basis from the Roth prior to death, leaving mostly earnings behind. With this unlikely combination of events the beneficiary might incur a taxable distribution. And even in that case, there would be no penalty because of the death exception to the early withdrawal penalty.

Any Roth beneficiary needs to do some research to determine the characteristics of the Roth they inherited. They need this information in order to report any distributions they take, RMD or otherwise. Most owners probably do not have this data well documented. This means contacting the Roth custodian and perhaps the tax preparer and/or executor to secure this information. Having acquired the info, they can determine how much of the Roth is available tax free and when. I think that in most cases this fact finding is probably done after the fact.



Submitted by Joanne Lamora on Fri, 2009-09-25 13:41

Am I correct in assuming, after reading this thread, that any TIRAs/401Ks converted to Roth IRAs after age 59.5 have no five year holding period before distributions can take place?
I have read the IRS publication and researched this topic on the internet…there seems to be a lot of ambiguous information and confusion.
Thank You!



Submitted by Alan Spross on Fri, 2009-09-25 19:06

Correct. There is no conversion 5 year holding period for conversions after the taxpayer reaches 59.5. This includes conversions done prior to age 59.5 as well once the taxpayer reaches 59.5. Conversion dollars can be distributed at any time after 59.5 without tax or penalty.



Submitted by Bill Lohss on Sun, 2009-09-27 01:31

Alan:

You said: “Conversion dollars can be distributed at any time after 59.5 without tax or penalty.”
But earlier you also said: “As far as taxation on earnings, that depends on a different 5 year requirement. This one starts with the year of your first Roth contribution.”

I get that after 59 1/2 there is no 10% penalty tax applied to distributions of conversion-related amounts, because 59 1/2 is one of the exceptions that nullifies the penalty. However, my understanding – from the second statement above – is that you can still incur tax on earnings [i]unless[/i] 5 years have elapsed since your first Roth contribution (or conversion). Therefore, the first statement quoted above is incomplete isn’t it? You can still incur tax (but not penalty) on conversion distributions even if you are older than 59 1/2 unless you also have met the single 5-year holding period requirement?



Submitted by Alan Spross on Sun, 2009-09-27 02:44

You do not incur tax on the conversion dollars, but you would incur tax on the earnings generated by any regular or conversion contributions that had been made. The earnings are not part of the conversion dollar balance, they are a separate category in a Roth IRA.

Until a Roth becomes qualified (5 years from first Roth plus age 59.5 in most cases) the entire balance at any point in time is broken up into categories of regular contributions, conversion contributions and earnings. In order to report any distribution on Form 8606, the taxpayer must be aware of this balance and the “ordering rules” or the 8606 will be incorrect. But the statement is correct as limited to the actual balance of conversion dollars in the account.

Once the Roth is qualified, these categories no longer matter, since all distributions from the point on are always tax and penalty free. The sub totals can then be forgotten, and the 8606 is also no longer needed.



Submitted by Bill Lohss on Sun, 2009-09-27 13:40

Thank you Alan. I believe you have already stated this, but just to underline: Once I have (1) owned[i] any[/i] Roth account for at least 5 years and (2) am 59 1/2 then [i]any and all[/i] distributions of my contributions or conversions (and attributable earnings) are “qualified” and therefore free of income and penalty tax. Correct? Nothing has to be reported to the IRS and no 8606 has to be filed?



Submitted by Alan Spross on Mon, 2009-09-28 04:09

Correct. Applies separately to owned Roth accounts and inherited Roth IRAs.



Submitted by Anonymous (not verified) on Mon, 2009-09-28 04:41

alan:

Do you know of a rule where the 5-year clock is extended in the scenario that a Roth 401K with 5 years tenure (as soon as that is possible) is rolled over to an only Roth IRA, that [u]only[/u] has 2 years of tenure, and the owner (over 59 1/2) has to wait for 3 years for all earnings to be tax-free? Or some other scenario involving the Roth 401K and not consistant with the above discussion.

Thanks.

pmk



Submitted by Alan Spross on Mon, 2009-09-28 05:23

Yes, but it is not found in Pub 590.
If a designated Roth account (Roth 401k) becomes qualified in the 401k and is then rolled over to a Roth IRA, it is considered as a regular contribution to the Roth IRA for accounting purposes under the ordering rules. The result is that it can be withdrawn from the Roth IRA tax and penalty free, even though the Roth IRA itself has not yet reached qualification. The holding period of the Roth IRA is not changed because of the rollover, so Roth IRA earnings are not yet qualified, but they would come out last in the event of subsequent Roth IRA distributions before the IRA was qualified.

This rule is part of IRS releases regarding Roth 401k distributions and rollovers. I expect Pub 590 will be updated, perhaps with the 2009 edition. Although Roth 401ks could not yet be qualified, the ordering rules still need updating to address the rollover of non qualified Roth 401k accounts. In that instance the earnings portion of the Roth 401k is added to Roth IRA earnings instead of Roth IRA regular contributions as indicated above in the case of the designated Roth becoming qualified.



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