Age 59 1/2, ROTH Conversion, no previous ROTH

Submitted by Bill Briner on Mon, 2009-12-28 22:39

If someone is 59 1/2 or older, does not have any prior ROTH IRA’s and makes a ROTH Conversion in 2010, can they take distributions of both the conversion amount and the earnings at any time without any waiting period or 10% penalty?

Thanks.



Submitted by mk foss on Mon, 2009-12-28 22:55

An individual who converts an IRA to Roth and is over age 59-1/2 will have no 10% penalty on any withdrawals.

Distributions from the Roth automatically come from the following sources (in order):
1. Contributions
2. Conversions – taxable portion
3. Conversions – nontaxable portion (due to IRA or qualified plan basis)
4. Earnings

In order for earnings to be tax free the Roth must be open for 5 years. The Earnings are not earnings in the traditional sense – the earnings are the difference between the FMV of a withdrawal reduced by any unrecovered basis in contributions and conversions.



Submitted by Bill Briner on Mon, 2009-12-28 23:54

Let me make sure I understand correctly — say that a $100,000 ROTH conversion is made in 2010 and 2010 income taxes are paid from other after tax savings. Let’s say that 11 months later, the value of this ROTH IRA is $102,000 and the entire amount is withdrawn at that time (this person is older than age 59 1/2 and did not have any ROTH IRA’s prior to this conversion). Do I understand correctly that $100,000 of the distribution is not subject to regular income tax or an additional 10% tax, but $2000 of this distribution is subject to regular income tax (but not an additional 10% tax)?

Thanks.



Submitted by Alan Spross on Tue, 2009-12-29 00:36

Exactly. The earnings would be taxable if withdrawn prior to 2015, but no penalty.

Also, note that 2010 conversions are unique in that the income is not reportable until 2011 and 2012 UNLESS the taxpayer opts to report the entire conversion in 2010. If the two year deferral applies and the entire account is withdrawn in 2011, then the entire conversion will also be taxed in 2011 since the 2012 portion will be added to the 2011 portion. You would then have all 102,000 taxable in 2011. If the taxpayer opts out of the deferral, then the conversion will be taxable in 2010 and the earnings will be taxable in the year the distribution is taken. This would all be reported on Form 8606.



Submitted by Bill Briner on Sat, 2010-01-02 05:51

Thanks to both of you for explaining this. A friend of mine is in the situation I described above. I, on the other hand, opened my first ROTH IRA 10 years ago, therefore, as I understand it, I am no longer subject to either of the 5 year waiting periods since I am over 59 1/2 (i.e., I can make a ROTH conversion this month, pay tax on the converted amount in 2010 if I choose and take a distribution of both the converted amount and earnings in less than 5 years without paying any additional tax).



Submitted by Alan Spross on Sat, 2010-01-02 18:06

That is correct.



Submitted by Jen Erik on Sat, 2010-01-09 23:26

My situation is similar to that of wjbrin in his posting of Sat Jan 02, 2010 5:51 am
I’m over 59 1/2 and I have had a Roth IRA for over 5 years.

In 2010, I’m planning DISTRIBUTE some money from my Traditional IRA. This will be taxed in 2010.

As a SEPARATE transaction in 2010, I am planning to CONVERT some Traditional IRA money to my Roth IRA, and I’m planning to have this converted amount taxed in 2011 and 2012 (half in each year).

After the conversion, could I then immediately DISTRIBUTE THE CONVERTED AMOUNT from my Roth IRA without any penalty, tax, etc. AND still pay tax on the converted amount in 2011 and 2012?



Submitted by Alan Spross on Sat, 2010-01-09 23:59

No.
While any or all of your Roth distributions are now tax and penalty free, if you do NOT opt out of the two year deferral, any distributions that you take prior to 2012 will accelerate the date of your tax bill for the 2010 conversion.

Since your Roth is now qualified, any distributions that you take out with respect to the above rule will be deemed to first come from your Roth balance before your conversion, but I am not sure exactly when that balance is determined. Your conversion taxes would not be accelerated until you distributed this prior balance, ie you would not be deemed to be withdrawing converted amounts until these earlier amounts have been exhausted.

To keep this simpler, let’s assume that you had no prior Roth balance and therefore wish to tap into the actual funds you just converted in 2010. The acceleration affects any distributions you take from the converted amounts prior to 2012. Any amount you withdraw in 2010 will be taxable in 2010 instead of in 2012. This means a conversion of 50,000 that would normally be reported @ 25,000 in both 2011 and 2012 would be affected by a withdrawal of 20,000 as follows: 20,000 taxable in 2010, 25,000 in 2011 and 5,000 in 2012. The credit for the accelerated amount comes off the later year amount first.
If you took the distribution of 20,000 in 2011 instead of 2010, then you would report 45,000 in 2011 and 5,000 in 2012.

It therefore appears that the only benefit of converting amounts that you are going to withdraw is that any earnings in the Roth before you withdraw those conversion funds will stay in the Roth tax free. Otherwise, you really are not deferring any taxes by this strategy.



Submitted by Jen Erik on Sun, 2010-01-10 22:11

Thank you for your prompt reply.

Under my original assumptions:
over age 59 1/2 and
have had a Roth for 5 or more years

And under your added assumptions:
no prior Roth balance and
a $50,000 conversion in 2010 to be reported as $25,000 in 2011 and $25,000 in 2012

I understand the acceleration consequences if I took part or all of the conversion in 2010.

What I don’t understand is:
“If you took the [Roth] distribution of 20,000 in 2011 …, then you would report 45,000 in 2011 and 5,000 in 2012.”

Since $25,000 of the conversion is to be reported in 2011, shouldn’t I be able to distribute from Roth in 2011 up to $25,000 of this converted amount without any extra taxability? Or, in order to avoid extra taxability, do I have to wait until 2012 to distribute ANY of the converted $50,000?

N.B. In the last paragraph, I am using “extra taxability” to mean paying tax in 2011 on MORE than $25,000 of the converted amount.



Submitted by Alan Spross on Sun, 2010-01-10 23:36

Yes, you cannot take any distribution from the converted amount prior to 2012 or the income to be reported is deemed to have come from 2012 and added to the amount that you already would have had to report in 2011.

The purpose of this to eliminate the practice of taking funds out of a traditional IRA for your use, and deferring the tax bill by running the distribution through a Roth conversion and then distributing those same funds from the Roth.



Submitted by Jen Erik on Mon, 2010-01-11 00:54

Are the following interpretations correct (note that the amount “into my pocket” in 2011 & 2012 is the same in all cases)?

Case A:
Do these things:
2010: Convert $50,000 to Roth (and defer, etc.)
2011: Distribute $25,000 of converted amount from Roth
2012: Distribute $25,000 of converted amount from Roth
Consequences:
2011: $50,000 added to taxable income
2012: $0 added to taxable income

Case B:
Do these things:
2011: Convert $25,000 to Roth
2011: Distribute the $25,000 from Roth
2012: Convert $25,000 to Roth
2012: Distribute the $25,000 from Roth
Consequences:
2011: $25,000 added to taxable income
2012: $25,000 added to taxable income

Case C:
Do these things:
2011: Distribute the $25,000 from Traditional
2012: Distribute the $25,000 from Traditional
Consequences:
2011: $25,000 added to taxable income
2012: $25,000 added to taxable income



Submitted by Alan Spross on Mon, 2010-01-11 01:44

Yes, all are correct.



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