The 5-Year Forever Clock | Ed Slott and Company, LLC

The 5-Year Forever Clock

I Just read The 5-Year Forever Clock article. I thought that anytime you did a Roth conversion that a new 5 year clock started for the earnings of that particular conversion. Even though the IRA holder paid taxes on the $100,000 401K conversion. I thought any earnings on the $100,000 conversion would have to be held for 5 more years before those earnings would be tax free. My Roth IRA was first opened 8 years ago. However, I have done conversion every year for the past 3 years. I was told by someone claiming to be Slott trained that I needed to track those conversions, so that I will know when 5 years have passed so that my earnings will be tax free on each yearly conversion. I am confused now.

  • The taxable portion of a conversion must be held 5 years (or until age 59.5 if sooner) before it can be distributed without the 10% early withdrawal penalty. This has nothing to do with earnings or the taxation of earnings. This penalty only applies to the pre tax amount converted.
  • There is another 5 year holding period for Roth IRAs that determines (along with reaching 59.5) when the entire Roth IRA becomes qualified. That is when earnings from all Roth contributions become tax free. 
  • Unless you have reached 59.5, you still need to keep track of the taxable portion of each conversion you did in the last 5 years. If you withdraw any of these conversions before 5 years (or 59.5) you will owe the 10% penalty unless you qualify for a penalty exception. 
  •  What the rep should have told you is that you needed to track these conversions for purposes of the 10% penalty, not for purposes of ordinary income tax on the earnings. You never have to track earnings on conversions, or for that matter earnings at all. You track basis (regular contributions and conversions done). Earnings will be taxed only after you have withdrawn all your Roth IRA basis and at any point in time earnings in your Roth are the amount of the balance that exceeds what you contributed by regular or conversion contributions. 
 

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