10% penalty on distributions of Roth Conversions

My understanding is that if the 5 year waiting period is satisfied on Roth conversion money, then if a person takes a take distribution that includes that conversion money, it is not subject to the 10% penalty even if person is under age 59 1/2.

However, I came across the below statement, which appears to contradict.

From link: http://www.irahelp.com/IRAUpdates/jun10/

“Q: If a person converts to a Roth at the age of 57, does that person have to wait 5 years to withdraw the conversion amount and the earnings without paying a penalty?

A: You can always take a distribution of basis from a Roth IRA. Basis is annual contributions and converted amounts. Those distributions will NOT be taxed when they are withdrawn as they were subject to tax when they went into the Roth IRA (or they were already after-tax amounts).

There are ordering rules for Roth distributions. The ordering rules are as follows: contributions come out first; converted amounts come out next; funds that were taxable at the time of conversion come out before funds that were not taxable at the time of conversion; earnings come out last.[u] [i][b]A distribution of any converted amounts or earnings before age 59 1/2 will be subject to the early distribution penalty.[/b][/i] [/u]In addition, the earnings distributed will also be taxable.”

Lee



Your understanding is correct.

The underlined sentence in your last paragraph is the one that is worded poorly and creates the impression of a conflict. What it should have said is:

“A distribution of any converted amounts THAT WERE SUBJECT TO TAX before a 5 year holding period and before age 59.5 are subject to the early distribution penalty. In addition, any earnings distributed prior to 59.5 are also generally subject to this penalty.”

The error in the quoted statement arose from trying to cover too many issues in one broad statement.

The purpose of the 5 year conversion holding period was to prevent someone who wanted to avoid the penalty on an early TIRA distribution from first converting to get around the penalty. Congress decided to require a 5 year holding period before the funds could be distributed without penalty, assuming that no one would be likely to plan that far ahead for a needed distribution. But the penalty also ends at 59.5 because the person could have taken funds out of their TIRA on that date without penalty, so there was no reason to make them complete the 5 years after reaching 59.5.



Thanks!



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