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Showing posts with label Roth Conversions. Show all posts
Showing posts with label Roth Conversions. Show all posts

Roth IRA 5-Year Rules, Same-Sex Marriage Retirement Plan Guidance, Paying for a 2010 Roth Conversion

ed slott IRA information
The Roth IRA 5-year rules. The Department of Labor's recent guidance on how to treat same-sex marriage for employer retirement plans. Ways you could STILL be paying for a 2010 Roth IRA conversion.

Last week, America's IRA Experts descended on San Diego, California for our 2-Day IRA Workshop, Instant IRA Success. While we were in San Diego, we took the time to record some interactive, informational roundtables from the 30th floor overlooking the bay at the beautiful Grand Manchester Hyatt.

Below are 3 videos with our IRA Technical Experts and Slott Report staff writers. Enjoy this look at just a touch of the information covered over 2 days in San Diego. And if you are looking to gain a step on the competition and take your education to the next level, join us for our next 2-Day IRA Workshop in New Orleans on January 30-31, 2014.

And make sure to enter the Optional Registration Code "EARLY BIRD" to Save $500 off the full price.

SAME-SEX MARRIAGE AND RETIREMENT PLANS



ROTH IRA 5-YEAR RULES: WHEN CAN I TAKE A DISTRIBUTION?



2010 ROTH IRA CONVERSION: WAYS YOU COULD STILL BE PAYING




Slott Report Mailbag: Am I "Over Qualified" to Convert My 401(k) to a Roth IRA?

This week's Slott Report Mailbag talks about Roth IRA conversions, how they are taxed and whether President Obama's budget proposals would cap Roth IRAs. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Hello Mr. Slott,

Send questions to [email protected]
We are looking to convert an IRA to a Roth IRA. I took a loss on a variable life policy that was converted to an annuity. Can we use that loss to offset the tax due on a Roth conversion?

Answer:
The conversion to the Roth IRA is taxed as ordinary income. Please talk to a tax advisor or insurance professional with respect to whether or not you can deduct a loss on a variable life policy.

2.

Hello Ed,

I have been self-employed for over three decades and have made yearly maximum contributions to my 401(k) plan. I am now required to take yearly distributions, and in addition to continuing full-time employment, the taxes are killing me. It is my understanding that I am "over qualified" income wise and unable to set up or roll over into a Roth IRA.

What can I do to reduce my taxes?

P.S.

Death is not an option!

Kindest Regards,

Roger Posch

Answer:
Everyone is now eligible to convert funds to a Roth IRA. There are no longer income limits to do a Roth conversion. You should consider rolling over (converting) your 401(k) funds to a Roth IRA. All funds, except any 401(k) minimum distributions, are eligible to go into the Roth IRA. While the conversion will be taxable, the future withdrawals from the Roth IRA won’t be, if certain rules are met. Also, there are no required minimum distributions from a Roth IRA.

3.

I am unclear on the President's proposal to 'cap IRAs.' I see no reference to Roth IRAs where taxpayers have already paid full federal and state income taxes. Is he proposing to reverse or 'go back' on earlier promises of tax-free withdrawals from Roth IRAs?

Thank you,

Hugh Ditzler

Answer:
As part of the President’s fiscal year budget, he proposed limiting IRAs and employer retirement plans to a certain level based on a formula. That level is approximately $3 million. It is too early in the process to clarify any budget proposals. Also Congress has different ideas that will compete with the President’s proposals.


-By Joe Cicchinelli and Jared Trexler

Slott Report Mailbag: Did The New Tax Law Add Income Limits to a Roth Conversion?

This week's Slott Report Mailbag talks about how (if at all) the new tax law affected Roth conversion planning, as well as a look at Roth IRA rollover rules and the ways you can withdrawal 401(k) money early without penalty (can you do that?). As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

ed slott IRA, tax, retirement planning questions
Send questions to [email protected]
I want to convert to a Roth IRA in 2013. Did the 2013 tax law add any income limits to a Roth conversion?

Answer:
No. There are no income limits to convert IRA funds to a Roth IRA. Any IRA owner can do a conversion. There is also no limit on the dollar amount of IRA funds that you can convert to a Roth IRA.

2.

I wasn't happy with the investments inside my Roth IRA so I took a distribution from it and deposited the funds into a non-IRA investment account. I now found a great financial adviser and would like to roll over all that money into a Roth IRA with my adviser. It's within 60 days of the Roth IRA withdrawal. Can I do the rollover?

Answer:
Probably. In general, since it's within 60 days of the distribution, the amount of the Roth IRA distribution can be rolled over tax-free to another Roth IRA. It doesn't matter what you did with that money during the 60 days. Any gains you earned in that non-IRA investment account during the 60 days cannot be rolled over. However, if you have made any other Roth IRA-to-Roth IRA rollovers into or out of that account within the past 365 days, you would be prohibited from completing another rollover at this time, and would be forced to keep the funds in a non-Roth IRA account.

3.

I'm age 51, have a 401(k) plan, and would like to withdraw money penalty free for a down payment on a first home. Can I do that?

Answer:
No. The exception to the 10% early distribution for first home purchases applies to IRAs only; not 401(k)s. However, if you're entitled to take a distribution from the 401(k), you could roll over the funds to an IRA and then take a penalty-free IRA distribution from there, assuming you meet the other first-time home-buyer penalty exception rules.


- By Joe Cicchinelli and Jared Trexler

Don't Forget About Your 2010 Roth Conversion on Your 2012 Tax Return

As we gather our information to prepare our federal income tax return for 2012, don't forget about that Roth IRA conversion you did all of the way back in 2010. A conversion you did from a company plan or IRA to a Roth IRA in 2010 will likely need to be reported on your 2010 tax return.

Before 2010, there were restrictions on who could convert IRA money to a Roth IRA. For example, if you were single or married filing jointly, your modified adjusted gross income (MAGI) had to be less than $100,000 for the year to be eligible to do a conversion. If you were married filing separately, you could not do a Roth IRA conversion, even if your MAGI was less than $100,000.

Starting for 2010, the Tax Increase Prevention and Reconciliation Act (TIPRA) eliminated the $100,000 income limit, allowing you to convert your IRA to a Roth IRA, no matter how much your MAGI was for the year. Also, if you are married filing separately, you are now eligible for a conversion. Basically, every IRA owner could convert to a Roth IRA starting in 2010.

What is the general rule? When you convert IRA or company plan money to a Roth IRA, the conversion is taxed for the year the money was distributed from the retirement plan. But there was a special 2-year tax break for conversions done in 2010. Unless you chose to have the entire conversion amount taxed in 2010, none of the income from the conversion was taxed in 2010; instead, half of the income was taxed in 2011 and the other half in 2012.

If you did a Roth IRA conversion in 2010 and took advantage of the 2-year special tax break, remember that the remaining half of that 2010 conversion amount is taxable for 2012. To figure what’s taxable for 2012, simply go to your 2010 copy of IRS Form 8606, and look at the amount in line 20b, Amount subject to tax in 2012. This is the amount of income that needs to be added to your 2012 federal income tax return (IRS Form 1040).

If you took a distribution of any 2010 conversion funds in either 2010 or 2011, the amount to be included in income for 2012 should be reduced. The reduction would be calculated on Form 8606 in the Distributions from Roth IRAs section of the form.

Article Highlights
• If you did a Roth IRA conversion in 2010 and used the special 2-year tax rule, half of that income is taxable for 2012
• Your 2010 IRS Form 8606 will tell you what amount remains to be taxed for 2012.


-By Joe Cicchinelli and Jared Trexler

Slott Report Mailbag: Can I Claim Roth IRA Losses on My Tax Form?

A new tax law brings a lot of indecision, and we expect the questions to start pouring in over the Taxpayer Relief Act of 2012. In the short term, we continue to see many questions about how to forge forward with proper planning in 2013, outside any of the tax provisions from the new law.

This week's Slott Report Mailbag tackles Roth conversion income limits, Roth recharacterizations and the rules governing IRA distributions. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Did the income conversion limits on Roth IRA conversions expire with the Bush tax cuts at the end of this year?

Thanks

Wayne Sharpe

Answer:
There are no income limits to do a conversion to a Roth IRA. The prior income limit of $100,000 was permanently repealed beginning in 2010. Therefore, there is no income limit for a Roth IRA conversion in 2013.

2.

Hello Mr. Slott:

Send questions to [email protected]
I converted $64,000 over my Roth IRA in 2010 to take advantage of paying tax over a two-year period. What I wasn't expecting was for the account balance to drop to $10,000. I have read one of your responses on the web that there is pretty much nothing that I can do to recharacterize, BUT I believe that I once read that if you take a major loss within an IRA, you can withdrawal the money and claim the loss on your taxes. Yes, I know, it doesn't make much sense, but I am reaching as far as I can.

I've been laid off since 2010 so I'm doing everything possible to relieve our tax burden this April because of my conversion in 2010.

Thank you for any help you might be able to provide.

Michael Lally

Answer:
Unfortunately, the deadline to recharacterize your 2010 conversion (and eliminate the taxes owed) was October 15, 2011. The only way you can claim a loss is if you withdraw all the funds in all your Roth IRAs and the withdrawn amounts are less than the unrecovered basis (contribution and conversion funds). Then you have to itemize your deductions. Your itemized deductions must exceed 2% of your income before you can actually take a deduction. If you are subject to AMT, your deduction will be disallowed. If you are under age 59 ½, you could incur the 10% early distribution penalty on converted amounts.

3.

Let's say you have a $10,000 qualified education expense for graduate school for 2013. Can you take a distribution from your traditional IRA and place the funds into your state’s qualified 529 plan so that you can get a state tax deduction for that $10,000 of additional income that you will recognize for 2013?

Please let me know if you need any further details. I appreciate your help in advance.

Thanks.

Answer:
Once you take a distribution from your IRA, you can use those funds for any purpose you want. State tax laws vary, so we cannot answer your question on a state tax deduction. You should consult a tax preparer for help on that part of your question.


-By Joe Cicchinelli and Jared Trexler

Year-End Roth IRA Rules

A misconception we see frequently is individuals thinking they have until April 15th to do a Roth conversion for the prior year. The Roth conversion rules are not the same as the Roth IRA contribution rules.

In order to have a 2012 Roth conversion, the funds must be out of your IRA or employer plan by December 31, 2012. They do not have to be in the Roth account by that date, but they must be out of the distributing account. This will produce a 1099-R for 2012 and the income due to the conversion will be included on your 2012 tax return.

Another misconception is that employer plan funds must go to an IRA before being converted to a Roth IRA. This used to be the case, but is no longer true. Your plan funds can go directly from your plan to your Roth IRA. This is a conversion and any taxable amounts moved to the Roth IRA will be taxable for the year of the conversion.

The Roth contribution rules allow you to make a 2012 contribution up to April 15, 2013. Unlike Roth conversions, there are income limits on Roth contributions. You must have “compensation,” which is generally your earned income, in order to make a contribution that is at least equal to the amount of the contribution.

Your ability to make a contribution is phased out when your income is too high. For 2012, if you are married filing jointly, your ability to make a contribution is phased out when income is between $173,000 - $183,000. If you are a single filer the phase-out range is $110,000 - $125,000 and if you file married-separate, your phase-out range is $0 - $10,000.

You can even make Roth contributions after age 70 ½, as long as you still have earned income or some other form of “compensation.” You can also make Roth contributions while you are making 401(k) or similar employer plan contributions.

Roth IRAs can be a terrific addition to the array of retirement assets an individual counts on in retirement - but, they are not right for everyone. If you have any questions or concerns about Roth IRAs, you should consult a knowledgeable financial advisor. You can find a list of Ed Slott-trained advisors on our website, www.irahelp.com.

Article Highlights
  • Before 12/31 - Funds being converted to a Roth IRA must be out of an IRA or employer plan
  • By 4/15 - Roth IRA contributions must be made for the prior year
  • There are income limits for making Roth IRA contributions


-By Beverly DeVeny and Jared Trexler

Slott Report Mailbag: What is the Best Way to Leave My Roth IRA to Grandchildren?

You want to leave your Roth IRA to your grandchildren. You are worried about required distributions at age 70 ½ if you are still working. You want to know all of the tax specifics of a year-end Roth conversion. You have come to the right place, a special post-holiday Monday edition of The Slott Report Mailbag.  As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

Send your questions to [email protected]
1. I have converted some of my IRA to a Roth IRA, which I want to leave to my grandchildren who are minors. What is the best way to do this?

Answer:
Minors should not be named directly on the beneficiary form. They cannot sign the necessary paperwork to establish the inherited IRA, they cannot manage the investments, and they cannot request the required distributions (RMDs) each year. An intermediary needs to be named to act for the minors. The type of intermediary will depend on the size of the inheritance for the children. For a sizable account, generally the best thing to do is to set up a trust for the minors and name the trust as the beneficiary of the IRA. All the beneficiaries of the trust will have to use the age of the oldest trust beneficiary for calculating RMDs. In the trust you can stipulate the age the beneficiaries must attain in order to have access to the inherited Roth IRA funds.

For smaller accounts, you might be able to name a guardian for the minor either in your will or on the beneficiary form. You should check with the IRA custodian to see if either option is allowed without the necessity of a court appointment. Another option would be to name an UGMA (Uniform Gifts to Minors) trust as the beneficiary. In either of these scenarios, the grandchild would have access to the inherited account when he/she reaches the age of majority - either 18 or 21.

2. I will be 70 ½ this year and am still working and contributing to my 401(k). What required distributions will I have to take this year?

Answer:
You will have to take required distributions (RMDs) from any IRAs (including SEPs and SIMPLEs even if you were still working for the company that sponsors the plan) that you have and from any plans of employers for which you no longer work. There is an exception to the RMD rules for employer plans such as 401(k)s and 403(b)s if you are still working for that employer. If you are not a 5% or more owner of the company and if the plan allows, you can delay taking RMDs until you separate from service. Once you separate from service, you have a required distribution for the year of separation. You can defer taking that distribution until April 1 of the following year but you would then have to take the RMD for that year also by the end of the year. So you would end up having to take two distributions in one year. If you want to roll your employer plan funds over to an IRA, you will have to take any undistributed RMDs before you can roll the balance of the plan funds to an IRA.

3. I am ready to do a Roth conversion. When I go through with it, what part is taxable?

Answer:
If you have both pre- and after-tax amounts in your IRA and are doing a partial conversion, the pro-rata tax rule will apply. The formula is on IRS Form 8606. Basically, you take all the after-tax funds in all your IRAs and divide that amount by the year-end account balance in all your IRAs. The percentage is the percent of the amount converted that will not be taxable. You must include SEP and SIMPLE IRAs in these balances.

If you are converting assets in kind, i.e. the assets themselves are moving to the Roth IRA account, the value used will be their fair market value as of the date they are transferred to the Roth IRA. For most stocks, bonds and mutual funds this will be easy to determine. For non-publicly traded assets, you will need to have an appraisal done. If you are converting annuities to a Roth IRA that have riders for guaranteed benefits, the current fair market value of those riders must be calculated by the insurance company as part of the valuation of the asset on the date of conversion.


-By Joe Cicchinelli and Jared Trexler

Slott Report Mailbag: Can I Perform More Than One Taxable Roth Conversion Per Year?

This week's Slott Report Mailbag comes LIVE from The Cosmopolitan in Las Vegas as we get ready for Ed Slott's 2-Day IRA Workshop this Saturday and Sunday.  We answered questions on Roth conversions, the Roth IRA 5-year rules, and where an IRA goes at your death. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Is it possible to perform more than one taxable Roth conversion during one 12-month period? Thanks you.

Send your questions to [email protected]
Amy Brocious

Answer:
Yes it is. The one-rollover-per-year rule does not apply to conversions to Roth IRAs.

2.

I began my 401(k) Roth deferrals in 2005 and contributed 3,000. In 2010, I put 5,000 in a Roth IRA. I rolled the 401(k) Roth funds into Roth IRA in 2011 (due to loss of job). Then later in 2011, I rolled the entire Roth IRA to another company (where current plan is).

Does the 5-year clock start over in 2010, 2011? Or does each Roth type (IRA and 401(k)) have 2 different 5-year clocks? Thank you.

Answer:
The rules are a bit complicated, but basically the rollover from your Roth 401(k) to your Roth IRA in 2011 was six years from when you contributed in 2005. So if you were age 59 ½ or older when you did the rollover, then the rollover is considered a qualified distribution. For a qualified distribution of a Roth 401(k) to a Roth IRA, the entire amount of the distribution will be treated as a regular contribution (basis) and is available for distribution tax free. The 5-year Roth IRA holding period would not apply to these funds.

If you were not age 59 ½ or older when you did the rollover from the employer plan, then the rollover is considered a non-qualified distribution. When a non-qualified distribution is rolled over to a Roth IRA, the portion of the distribution that constitutes a non-taxable return of investment in the contract (your Roth 401(k) deferrals) is treated as contributions (basis) in the Roth IRA for the purpose of the ordering rules. The 5-year holding period for the distributions of earnings on those funds will be the period applicable to the Roth IRA which started in 2010.

3.

I have a substantial IRA that goes into a trust when I die and whereby my spouse will continue to draw the income from the IRA upon my death and upon her death the IRA goes to my grandchildren. However, I have been told that if I die, the IRA must be liquidated and that the only way it would not be liquidated is if my wife is the sole beneficiary. My question is two fold. Is this correct? Or is there another way that my wife could benefit from the income generated by the IRA without the government taking a big chunk?

Thanks
Pat B

Answer:
No it’s not correct. Remember that your IRA does NOT “go into” a trust at your death. The trust becomes the beneficiary of the IRA and only has to take RMDs (required minimum distributions) from the inherited IRA each year. There is no rule that says that if your wife is not the sole beneficiary, the IRA must be liquidated. If the trust is a look-through trust, then death distributions will be made using your wife’s single life expectancy. If the trust is not a look-through trust, then death distributions will be paid over five years if you die before your required beginning date (RBD, generally April 1 of the year after attaining age 70 ½), or paid over your remaining single life expectancy if you die after your RBD.


- By Joe Cicchinelli and Jared Trexler

Roth Conversion Tax, Inherited IRA and RMD Questions Highlight Slott Report Mailbag

As crisp temperatures and autumn colors cascade through our neighborhoods, people start eying year-end IRA and tax planning.  We saw it in this week's Slott Report Mailbag with questions about a Roth conversion and paying the tax associated with it, distributions from inherited IRAs and the rules regarding what you can and can't do with RMDs (required minimum distributions). As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

ed slott IRA, tax and retirement planning questions and answers
Send questions to [email protected]
1.

I am doing a partial conversion of my traditional IRA to a Roth IRA. I know that I will owe taxes and will use another source (not the traditional IRA) to pay the taxes. One way I am thinking about covering the taxes is to use stock losses (realized in my brokerage account). Is there a calculation to figure out how much of the taxes I will owe for the conversion will be covered by the stock losses from my brokerage account?

My guess is that it depends on the tax bracket for my AGI (adjusted gross income), which will be lower as a result of the stock losses, but I'm wondering if there is a calculation to help me approximate how much stock losses from a brokerage account would offset the taxes owed for the partial conversion. I hope this question makes sense and thanks for taking a look. Keep up the great work and thanks for the help!

Thanks,

Jeff A

Answer:
It does depend on your AGI and corresponding tax bracket. Tax deductions, tax credits and other tax benefits can be used to offset Roth conversion income - but NOT capital losses. Capital losses can only offset capital gains and up to $3,000 of other income like Roth conversion income.

One thing we frequently recommend is that you run the numbers through a tax program. You do two “returns,” one with the Roth conversion and one without. That will give you the truest picture of the impact of the conversion on your taxes. In your case, you can play around with various stock loss amounts to see what works best for you.

2.

I have two inherited accounts after the death of my sister, one an IRA and the other a Roth IRA. When I take my minimum distribution based on my life expectancy next year, does the distribution have to come out of each account separately or can I take it out of whichever account I choose?

Answer:
The distribution must be taken from each inherited IRA. The tax treatments are different for each one (i.e., the IRA is taxable and the Roth is generally tax-free). Also, you cannot combine the two inherited IRAs.

3.

Hi Ed,

If someone is over age 70 1/2 and starts taking their RMD for a given year, can they "convert" this RMD amount over to a Roth IRA? Assume the person has no earned income and is only considering converting the RMD amount for the year into a Roth, not any other portion(s) of their Traditional/Rollover IRAs.

Lastly, what if they do have earned income? I think the answer is "No" for both situations.

Thanks,

Matthew Holmes
Cincinnati, OH

Answer:
You are correct. The answer is "No" for both situations. RMDs can never be converted to a Roth IRA. However, if someone over age 70 1/2 has earned income, they can make an annual contribution to a Roth IRA assuming their total income does not exceed certain levels (e.g., $173, 000 in 2012 for a married couple filing jointly).


4.

If you are not working and your wife is employed, can you contribute to a Spousal IRA that is not in her name? Assume that income is not over the threshold of $173,000 if you are married filing jointly. Income earned by the spouse is more than the contribution.

Regards,

Al Horila

Answer:
Spousal contributions can be made to your IRA using your wife’s income (compensation). Your IRA must be in your name only; it cannot be in your wife’s name. There is no income limit to contribute to a traditional IRA but there is a $173,000 income cap in 2012 for contributing to a Roth IRA if you are married filing jointly.


- By Joe Cicchinelli and Jared Trexler

IRA, Retirement and Tax Planning Limericks

Retirement planning is a serious issue, a technical issue, one that involves very intricate terminology and an advanced, educated financial team to make sense of it all. But, sometimes, the basics can be broken down in interesting ways, hence The Slott Report's IRA, retirement and tax planning limericks.

ed slott IRA, retirement and tax planning limericksWe will post one of them every hour through 4:00 p.m. (ET).  Enjoy, let us know which is your favorite and share them on Facebook, Twitter, LinkedIn and with friends, family, colleagues and clients.

Taxes can be such a pain
And they show no signs they will wane
But converting today makes future ones go away
So you can enjoy all the gain

A proper beneficiary form
Really should be quite the norm
But few have them right and it’s an unfortunate sight
To see a beneficiary ending up scorned

IRA contributions may seem small
You might think they are nothing at all
But thanks to compounding growth can be quite astounding
So retirement can be a ball

IRA trusts are complex
Even experts can often be vexed
So make sure there is need before you proceed
To increase chances of success


- By Jeff Levine and Jared Trexler

RMD and Roth IRA Conversion Questions Highlight Slott Report Mailbag

Fall is upon us, at least that's what we think every time we walk past a coffee shop.  People are beginning year-end retirement planning preparations, and this week's Slott Report Mailbag includes questions on required minimum distributions (RMDs) and two different scenarios for Roth conversions.  As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.


1.

My wife, Susan, retired as a New York City teacher in 2003.

If she resumes employment with a different employer (which employer does not have a 403(b)) plan, is she entitled to defer RMDs past the regular age 70 ½ date?

If not, what if the new employer has a 403(b) plan? Is she entitled to defer if she “goes back” as a substitute teacher or administrative employee with the same employer, i.e. New York City Board of Ed?

Answer:
The rule is that you can only defer RMDs in the plan of the employer where you are currently employed. For example, you retire from McDonald's and get a job with IBM. Both companies have a 401(k) plan. You can only defer RMDs from the IBM plan because that is your current employer. You will have to take RMDs from the McDonald's plan.

2.
Send your questions to [email protected]

Hi Ed:

I'm thinking of rolling over either a portion, or all, of my regular IRA as well as my Defined Comp. plans to a Roth IRA. I am now retired and will not need to draw on them and would like to leave them to my beneficiaries for tax purposes. If something happens to me within five years of the rollover will they have a problem?

Thanks,
Jim M

Answer:
The conversion of your IRA or Qualified Retirement Plans to a Roth IRA will be taxable to you when you convert the funds. If you die within five years of the conversion, your beneficiaries will not be taxed on the withdrawal of the conversion funds because you already paid taxes on those funds. Also, they will not have to pay the 10% penalty because the penalty is waived for death distributions. Lastly, if your beneficiaries withdraw the earnings on the converted funds within five years, assuming this is your first Roth IRA, they will be taxed on the earnings only, but no 10% penalty.


3.

Dear Mr. Slott,

A few days ago, I watched your program on PBS in which you highly recommended to rollover a 401(k) to a Roth IRA. I would like to ask you for a favor to advise me what to do, rollover my 401(k) to Roth IRA or just to Traditional IRA? I am a 77-year-old retiree and my current tax bracket is 15%. Every year I have to get the maximum distribution without penalty from my 401(k) to supplement my Social Security for my family expenses.

I greatly appreciate your kind advice.

Sincerely,
Ton Le


Answer:
The decision to convert funds is an important one. Here are some general principles. A rollover from your 401(k) to a Roth IRA will be taxable so you’ll have to come up with the money to pay the taxes on it, ideally from non-retirement plan funds. Converting funds at the 15% tax bracket is relatively inexpensive and beneficial, but the conversion could put you in a higher tax bracket. It could also affect your deductions, exemptions, credits and phase-outs as well as make some of your Social Security income taxable. Withdrawals from Roth IRAs are generally tax-free. However, because you’ve indicated that you use your 401(k) distributions for your family expenses, you’ll initially have more expenses (i.e., the tax bill on the conversion) after the conversion. Speaking with a competent advisor is recommended.


- By Joe Cicchinelli and Jared Trexler

Roth IRA Rollover Rule, 10% Penalty Exception and Roth IRA Conversion Questions Highlight Mailbag

Can you believe summer is almost over?  Yet, The Slott Report Mailbag was full of pertinent IRA and retirement planning questions from consumers who are trying to make the right decisions as the dog days rapidly turn into fall.  This week's installment includes questions (and our answers) on the 60-day deadline on Roth IRA rollovers, 10% penalty exceptions and Roth IRA conversions. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.


1.

ed slott IRA and retirement questions
Send your questions to [email protected]
I am over 80 years old and have sufficient funds in my Roth IRA to purchase a new residence. If I withdraw a down payment and the purchase fails, may I reinvest the same amount that I withdrew for the down payment back into my Roth IRA?

Thanks,

John Heller

Answer:
Yes, but only if you get the funds back to the Roth IRA by rolling them over within 60 days from the date you receive them. IRS has the ability to extend this 60-day deadline, but they generally will not grant an extension when the funds were used while they were out of the IRA. In order to request an extension, you have to file a private letter ruling request and pay a fee to IRS. In addition, there will be a fee to a professional to prepare the request. There is no guarantee that IRS will grant a request for an extension, and it typically takes six to nine months for a ruling to be issued.

2.

Can a person avoid the 10% withdrawal penalty and filing 72(t) if he or she uses withdrawals to pay for health insurance premiums?

Answer:
There is an exception to the 10% early distribution penalty for withdrawals from an IRA when the account owner is unemployed and pays for health insurance. The full requirements that need to be satisfied to qualify for this exception can be found in IRS Publication 590. It is available on the IRS website, www.irs.gov. On the left hand side of the screen click on "Forms and Publications."

3.

I have $700,000 in an IRA and have considered converting to a Roth IRA as you have recommended. Taxes will have to be paid from the IRA funds.

Question: Should I convert the entire $700,000 this year or do a conversion of 50% this year and 50% next year? Will the tax consequence be less with a 2-year conversion?

Also my wife has earned income of approximately $145,000 per year.

Thank you,

Ken Jordan

Answer:
The decision to convert has many components to it. One of the first things we recommend is that you do two sample tax returns, one with the conversion and one without. Most individuals have their tax returns on a computer these days, which makes this fairly easy to do. The reason that it is important is that when you add income to your tax return many different parts of the return are affected. You could lose tax deductions, credits or exemptions. You might become subject to the alternative minimum tax. Social Security benefits could become taxable. By splitting the conversion over two years, you could become subject to higher tax rates next year - but you won’t know this until Congress acts on the sunset provisions of the Bush tax cuts.

It generally is not a good idea to pay for the conversion tax with IRA funds. This depletes the amount you will have available to you in retirement. Also, you will owe income tax on the amount you use to pay the tax and a 10% early distribution penalty if you are under the age of 59 ½ because those funds were not converted. If you later want to recharacterize your conversion, the funds used to pay the income tax will be “lost.” You will not be able to recharacterize amounts that are not in the Roth IRA.


-By Joe Cicchinelli and Jared Trexler

Roth IRA Conversion Taxes, Excess IRA Contribution Questions Highlight Mailbag

This week's Slott Report Mailbag includes some detailed questions (retirement planning is complicated, you know!) on Roth IRA conversion taxes, excess IRA contributions and the process of combining Roth IRA accounts. We hope you enjoy these Thursday mailbags, and make sure to send your question to [email protected]  As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Hello Mr. Slott,

ed slott IRA and retirement planning questions
Send your questions to [email protected]
I just withdrew $26K from a Roth IRA annuity that was opened in 2010. I have pre-paid the principal taxes for the Roth conversion (original conversion of $45K). Because this withdrawal is less than 5 years, I will need to pay tax on this gain. The annuity company says the tax is undetermined because it is a Roth. Do I determine the gain based upon my original conversion basis and try to discover the gain on that basis before the withdrawal? Shouldn’t the annuity company be able to provide me this amount of gain?
Thank you,

Jeff L. Moore

Answer:
The annuity company cannot provide you with that information because if you have other Roth IRAs, they must be included as well to determine the taxes due, if any. You or your CPA must calculate any taxes or penalties due. Under the ordering rules for Roth IRAs (where all Roth accounts are treated as if they were one Roth IRA), contributions are distributed first, tax free and penalty free. Next, conversions are distributed tax free because you’ve already paid taxes on that amount. However, if you are under age 59-1/2 and it’s been five years or less since the original $45K conversion, then you’ll owe a 10% penalty for removing conversion funds too soon (unless an exception to the penalty applies). IRS Form 8606 will walk you through the steps on whether or not this distribution is subject to any taxes or penalties.

2.

Here is my situation:

Anne and I have always filed a joint tax return. The excess contributions to our IRAs were caused by incorrectly including deferred compensation with self-employed income for calculating the maximum IRA contribution. All contributions were from after-tax funds. All accounts are held at the same financial institution.

For the 2009 tax year, on 4/13/2010, I made a $6000 after-tax contribution to my Roth IRA and $6000 to Anne’s Roth IRA. Our MAGI was $142K. After removing the deferred compensation from the calculation our total compensation for the tax year 2009 was $2320. The excess contributions were thus a total of $9680. In the tax year 2010, we had no compensation usable for IRA contributions and in 2011 our MAGI was too high for a Roth IRA contribution. It is likely that our MAGI will be too high for a Roth IRA contribution in 2012.

My proposed solution:

I will divide the $9680 excess contribution as follows: $5000 to Anne’s Roth IRA and $4680 to my Roth IRA). This will ensure that some contribution was made to her Roth in 2009 beginning the 5-year period.

First, prepare two Forms 5329 for 2009 for Anne and I entering $5000 and $4680 on line 23 and 24. I will calculate the 6% tax on line 25 for both forms ($300 and $280.80, respectively). No earnings need be considered. Second, prepare two Forms 5329 for 2010 for Anne and myself entering $5000 and $4680 on lines 18 and lines 24 and calculating the same 6% taxes on lines 25. Again, no earnings need be considered. Third, prepare two Forms 5329 for 2011 in the same way. The total tax will be: $1742.40. Submit a check and the six forms to the IRS. They will probably charge me interest on the back taxes, so I should file the forms and pay the taxes as soon as possible. Lastly, before the end of 2012 (say October) have my financial institution send us $5000 and $4680 from the two Roth accounts. This is not a recharacterization, but a simple distribution. No earnings need be removed. No 6% tax will need to be paid in 2012. No amended 1040 will need to be filed.

My questions: can you comment on whether this is correct? Should I enclose a letter to the IRS explaining what I have done?

Ernest

Answer:
Ernest - It looks as though you have a good grasp on your excess contributions and the penalties involved (I have not checked your math). Generally you must notify the custodian that your distribution is a return of an excess contribution. This allows them to use the appropriate codes on Form 1099-R. However, since you are correcting your excess contributions after the applicable deadline, there is no code for a return of an excess contribution. You will want to retain the backup for your calculations in case of any follow-up by IRS.

3.

At one of my banks, I have 2 Roth IRA CD's. One is a conversion and the other was set up as a Roth from the beginning. My bank told me I am not allowed to combine these two. My other bank allowed me to do this about one year ago.

I found something online that I think allows me to do this, and it is something called technical corrections to the Internal Revenue Service Restructuring and Reform Act of 1998. Do you know if I have to keep these accounts separate?
Thanks,

Sue Gerber

Answer:
Your Roth IRAs can be combined. In fact, when figuring out whether or not a Roth IRA distribution is taxable, the law combines them all and looks at it as one Roth IRA. Originally, Roth conversion funds had to be kept separate, but that rule changed many years ago. You may want to transfer those two Roth IRAs to a more enlightened financial organization or financial adviser.


-By Beverly DeVeny and Jared Trexler

IRAtv: Roth IRA Contribution and Conversion Differences and Limits

Ed Slott answered a consumer question about Roth IRA contributions and conversions in this installment of IRAtv. America's IRA Expert details the differences, limits and processes involved with Roth IRA contributions and conversions. You can subscribe to our IRAtv page by CLICKING HERE. 
IRAtv videos can also be seen here at The Slott Report and at our website, www.IRAhelp.com.



-By Ed Slott and Jared Trexler




IRA Rollovers, Roth IRA Conversions and Inherited IRAs Highlight Slott Report Mailbag

This week's Slott Report Mailbag answers your questions on IRA rollovers, the Roth conversion conversation when dealing with Social Security benefits as added income, and inherited IRAs. We answer situational questions asked by individuals, couples, and parents who are searching for the best way to leave an inherited IRA to their daughters. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.
Slott Report Mailbag
Send questions to [email protected]

I transferred a stock from my IRA to my regular (non IRA account) and then transferred the exact same number of shares of the same stock back into my IRA within 60 days. However, the value of those shares was $10,000 higher.

Do I have a problem because I put more money into the IRA even though I transferred the same number of shares?

Thanks,

Mark

Answer:
There is no problem. Your distribution of property (shares of stock) from your IRA qualifies to be rolled over tax-free within 60 days only if the identical stock is rolled over to a receiving IRA. It is common for the value of stock to change during the 60-day window. That’s OK and still qualifies as a tax-free rollover. When your tax return is filed for the year, your tax preparer may want to attach a note to explain the different values.

2.

We currently have $460,000 in traditional IRAs. I am 65 years old and must start taking RMDs (required minimum distributions) at 70 1/2 years of age. We also have $150,000 in Roth IRAs over 5 years old. My wife and I are not consuming any IRA money at this point. I do have the funds to pay the taxes on conversion from outside the IRAs.

We are both on Social Security and a fixed benefit pension, but have low expenses and no outstanding debt. If we convert some of the IRAs each year from now to 70.5, it will make 85% of our Social Security taxable each year, while it is only taxed a small amount now. Would it be better to do it all the conversions in one year, bite the bullet and pay the higher tax rate, or do 10 or 20% each year, thus having to include 85% of our Social Security as income? What do you think?


Answer:
The taxation of your Social Security benefits is one of many factors to look at. Whether you should convert your IRA to a Roth IRA depends on many other factors. Basically, you must decide whether the future benefits of the Roth IRA (i.e., tax-free withdrawals) are better than the cost of paying taxes on the conversion.

IRA owners who have non-retirement plan money to pay the taxes on the conversion often benefit from a conversion because they are not depleting their tax-advantaged retirement plans to pay taxes. There are also benefits from a Roth IRA as an estate planning tool (i.e., to leave funds to heirs tax-free).

We recommend that you speak with a qualified advisor who can get more detailed financial and tax information from you to help you make the right decision.

3.

Our son died of cancer last year and left his approximately $85,000 taxable funds to my husband and myself, each getting half. However, his instructions were that the funds were to go to his four sisters. We rolled the funds over into an inherited IRA, with the plan of taking it out over 3 years, paying the taxes (we don't have enough income to pay taxes, but adding this amount will make it necessary for us to pay taxes on our Social Security, which we have never needed to do) expecting the girls to choose cash or rollover if one of us passes before the 3 years is out. The first distribution would be taken this December.

I am 79 and my husband is 90.

Is there any better way to do this to lessen the tax burden?

Answer:
We will assume that by taxable funds you mean that you inherited either an IRA or an employer plan from your son. We will also assume that you did a direct transfer of the funds from his IRA to a properly titled inherited IRA - example Son, deceased, IRA fbo Parent - and that a check was not payable to you.

Now, can you lessen the annual tax burden? Only by taking smaller distributions each year. Your husband’s required distribution should be less than $8,000 on his half of the inherited $85,000 and your required distribution would be even less than that. In addition to the income taxes owed on the IRA distribution and on your Social Security payments, you may also see an increase in your Medicare Part B premium two or three years from now as that is also based on your annual income. You might want to look at the tax costs if you empty the account in one year compared to the tax costs if you empty the account over three years to see which method will actually cost you less. You might also want to consider asking the girls to help you out with the tax costs.

This was an expensive way for your son to leave some funds to his sisters. It would have been better all around if he had simply named them on the beneficiary form. Then any taxes due would have been their responsibility, and if they had wanted to stretch out the distributions they could have done so over their own life expectancies.

In order for the girls to be able to keep the funds in an inherited IRA at your death, they must be named as successor beneficiaries of your inherited IRA. Distributions at your death (or at your husband’s death) would have to continue to be made using your life expectancy, not the life expectancy of the girls.

-By Joe Cicchinelli and Jared Trexler




Excess IRA Contributions, Company Plans, Roth Conversion Conversation Highlights Mailbag

This week's Slott Report Mailbag includes questions on excess IRA contributions, company plan rules and the Roth IRA conversion conversation. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Dear Ed,

Send questions to [email protected]
If a person makes contributions to an IRA then realizes they are over the income level to get a tax deduction, can they remove those contributions plus income if they haven’t filed their tax return for the year of the contributions?

Situation: $4,800 was contributed to an IRA in 2011. I am extending my tax filing so I have not filed Form 8606 for 2011. I filed the IRS Form 5498 showing the contributions.

If I can remove the contributions, what steps do I need to take?

Thanks for your help.

Rita

Answer:
You have until October 15, 2012 to remove the $4,800 plus income as an excess contribution. The income will be taxed for 2011 (the year in which the deposit was made) and thus should be reported on your 2011 tax return. Another option is recharacterize (change) the $4,800 to a Roth IRA contribution for 2011, if your income is within certain limits. IRS Publication 590 shows how to remove or recharacterize the contribution plus income. You can find it at www.irs.gov; on the left hand side of the screen click on Forms and Publications.

2.

Dear Mr. Slott:

I have a 457(b) plan from a private university where I was previously employed.

I have to make an irrevocable decision on distributions - 30 year fixed vs. Minimum Distributions and the latter is much more favorable in regards to heirs.

However it not clear from what I have be able to gather if the MDO in such a plan can be stretched to my children as beneficiaries after my wife's death / my death. Also can I exercise disclaiming the inherited 457(b) plan to pass onto my children at their life expectancy?

Thank you for any help you can provide on this matter.

Sincerely,

Fred Petry

Answer:
As long as you leave your funds in the 457(b) plan, you and your beneficiaries will be limited by whatever options the plan offers. They will be outlined in the Summary Plan Description for your plan. While the tax code allows for a disclaimer of assets at death, again, it is up to the terms of the plan to allow the use of a disclaimer.

3.

I'm 70 and my wife is 67. I have a SEP IRA in my name with a value of $55,000 and a rollover IRA with a value of $750,000. My wife has both a rollover IRA and a traditional IRA with a $160,000 in each. At our ages does it make sense to convert any of these to a Roth IRA? Our combined income from Social Security and dividends and interest is approximately $70,000. We can pay the taxes from our after-tax account.

Thanks,

Jim

Answer:
Basically, you must decide whether the future tax benefits of the Roth IRA (i.e., tax-free distributions) are greater than the cost of paying taxes on the conversion.

Generally, a conversion may be beneficial for IRA owners if your marginal tax rates are likely to be higher when you withdraw the money, because Roth IRA distributions would be tax-free. Having non-retirement plan funds to pay the taxes is beneficial because you and your wife won’t deplete your IRAs to pay the income taxes on the conversion. Also, you would be leaving the Roth funds to your beneficiaries tax-free.

The decision whether or not to convert depends on many factors and should be addressed by a competent advisor.


-By Joe Cicchinelli and Jared Trexler

IRAtv: Can You Consolidate Converted Roth IRA Funds?

We received an IRA mailbag question from Greg, who wanted to know if he could consolidate all of his separate converted Roth IRA funds into one account. Two important factors to answer this question are: 1)how long have the converted funds been in the Roth IRA? 2)how old is Greg?

Ed Slott provides that information and answers Greg's question in this IRAtv video on consolidating converted Roth IRA funds.





Compiled by Jared Trexler

Roth Conversions and Contributions, Creditor Protection Highlight Mailbag

This week's Slott Report Mailbag includes questions on Roth conversions and contributions, the always-confusing Roth IRA 5-year rules and creditor protection for IRAs. Happy a happy, healthy Memorial Day weekend and thank you to the servicemen and women who risk their lives daily to defend and protect us. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Hello,

I have purchased Ed Slott's program guide package. It's very helpful. Thank you very much.

I have a question regarding a Roth IRA conversion. There is no limit to convert from tradition IRA to Roth IRA. Can I contribute the $5,000 limit to a Roth IRA in the same year I convert the traditional IRA to Roth? In other words, will the amount I convert be counted as part of the contribution?

Thanks for the advice,

Tony

Answer:
Send your questions to [email protected]
Roth conversions are in addition to the amount you can contribute annually to a Roth IRA. You can convert $100,000 (or any other amount) to a Roth IRA and still make a contribution to any Roth account. Anyone can do a Roth conversion at any age. In order to make a Roth contribution, you must first have earned income (compensation) and your income cannot exceed certain limits. If you are married, filing jointly, your ability to contribute to a Roth IRA will phase out when your modified adjusted gross income is between $173,000 and $183,000. For individuals who file as single or head of household, the phase-out range is $110,000 to $125,000. You can find more numbers from 2012 IRA and tax tables at www.IRAhelp.com/2012.


2.

I have one question about the 10% penalty on non-qualified distributions.

Assumptions: I made my first Roth contribution 10 years ago. I converted an IRA to a Roth two years ago. Today I attain age 59 ½. Tomorrow I will take a distribution attributable to the Roth conversion.

The distribution will be a qualified distribution because I will be over age 59 ½ and I will have made my first Roth contribution over five years ago. Will the 10% penalty apply to the distribution because the conversion occurred less than five years ago? I thought the penalty only applied to non-qualified distributions.

Chuck

Answer:
There are two five-year rules for Roth IRA distributions. The first thing to keep in mind is that all of your Roth IRAs are considered one Roth account for distribution purposes. You could have your Roth contributions in one account and your conversion in another account, but for distributions they are treated as one account.

The first funds out of a Roth IRA are considered to come from your contributions, even if you take it from an account that contains no contributions, only converted amounts. Contributions are always distributed tax and penalty free, regardless of any five-year rule or of your age.

Once your contributions are gone, then your distributions are deemed to come from converted amounts, first in, first out. Each conversion is subject to its own five-year holding period. These distributions will be subject to the 10% early distribution penalty if you have not held it for five years and you are not yet 59 ½ on the date of the distribution. In your case, you are now over 59 ½ so the 10% early distribution penalty will not apply (it never applies to any distribution made after the age of 59 ½).

After your contributions and your conversions are totally distributed, then distributions come from earnings. This is where the other five-year rule comes in. In order for distributions of earnings to be tax and penalty free you must have established any Roth IRA more than five years ago and the distribution must be made after age 59 ½ or be due to death, disability of the account owner, or for a first-time home purchase (lifetime cap of $10,000).

You are now in the home-free zone. You have a Roth account established over five years ago and you are over the age of 59 ½. All distributions to you or to your beneficiaries will be tax and penalty free.


3.

Hi Ed and Beverly,

I would like to know if a Roth IRA is exempt from any and all tax liens from state and federal municipalities. I read that any account that has a maximum value of one million or less is also exempt. Can you also let me know if they are excluded from any and all collection agencies?

TKG

Answer:
State law generally provides creditor protection for IRAs. You will have to determine what protection your state provides for your IRA accounts. IRAs have federal protection in bankruptcy. The federal exemption is currently almost $1,200,000 since it is indexed for inflation. Under the federal bankruptcy rules any employer plans rolled over to IRAs are 100% exempt as are SEP and SIMPLE IRAs. The IRS can take (levy) your IRA for unpaid federal taxes.


-By Beverly DeVeny and Jared Trexler

Questions on QCD Tax Reporting and Roth Conversions Highlight Slott Report Mailbag

This week's Slott Report Mailbag answers questions about reporting qualified charitable distributions on your tax return, rolling after-tax 401(k) contributions to a Roth IRA and taking Roth IRA losses if the investment has lost substantial value. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.
Send your questions to [email protected]

1.

My husband Tom directly transferred a $2,000 contribution from his IRA through his IRA custodian to a qualified charity in 2011 to take advantage of the law that expired in 2011.

The IRA custodian financial services company has not reported this direct contribution to a charity on its 1099 nor deducted the $2,000 from his taxable income on the 1099.

I have not seen a story on the exact reporting requirements of such a direct IRA distribution to a charity in 2011.

Questions:

1) Is the 1099, as stated above, correct? (The financial services firm insists that it is correct.)

2) What should the letter from the charity to my husband state? (The charity is insisting that it not name the financial services custodian or the check number.)

Thank you!

Myra Shaughnessy

P.S. We met Ed Slott a few years ago at a UBS financial services lecture.

Answer:
The 1099 you received from the IRA custodian appears to be correct. It should not reflect the qualified charitable distribution (QCD) made in 2011. Your 2011 income tax return is where the QCD is reported. On line 15a you would enter the total amount of the 1099 for the IRA distribution and line 15b would be the total amount on line 15a minus the QCD amount. Just to the right of line 15b write in "QCD."

The letter from the charity should merely substantiate the fact that you made a contribution and the amount of the contribution.

2.

Mr. Slott,

Can "after-tax" contributions to my company-sponsored 401(k) be rolled over to a Roth IRA?

Answer:
The simple answer is yes. However, there is what is called a pro-rata rule that must generally be used when you have pre- and after-tax dollars being withdrawn from the 401(k) plan. This simply means that when the 401(k) plan contains both after-tax and pre-tax funds, then each dollar withdrawn from the 401(k) plan contains a percentage of tax-free and taxable funds based on the percentage of after- tax funds to the entire account balance.

Example:
Total amount in the 401(k) plan: $300,000
After-tax funds: $30,000

$30,000 / $300,000 = 10%
10% of every dollar withdrawn will be tax-free.
90% of every dollar withdrawn will be taxable.

3.

Ed,

I rolled an IRA over into a Roth and invested the Roth into a real-estate development in the Denver area, expecting a return of about 30%. It was actually in the closing stage when the market took the hit, the buyer backed out and the bank refused to renew the note; instead they foreclosed on the developer, who in turn filed bankruptcy and the investors lost 99% of their investment. Now, as the market down there recovers, the bank is reaping the millions of dollars from its opportune foreclosure strategy.

My question is this: can I take any of the losses that I took from the investment? Is there any strategy out there, where I might refund the Roth, and not lose the $50,000 Roth position?

Thank you,

Jim

Answer:
In order to take the loss, all Roth IRA funds must be withdrawn from all Roth IRAs owned by the client and the amount of basis (cost) must exceed the amount withdrawn. Any loss is claimed as a miscellaneous itemized deduction. The total of all miscellaneous deductions (including the IRA loss) must exceed 2% of adjusted gross income (AGI) to qualify as a deduction. If you are under age 59 1/2 there could be a 10% early withdrawal penalty if converted funds are withdrawn within five years of conversion. This information can be found in IRS Publication 590.

The only other option would be that a conversion could be recharacterized (means undone) no later than 10/15 of the year following the conversion. If the funds were valued a lot higher at the time of the conversion, the recharacterization would save on taxes paid.


-By Marvin Rotenberg and Jared Trexler

When Can I Take a Roth Distribution? It's All About the Rules

Last week I said that some taxpayers may be forced to take funds from their Roth IRA to pay the income tax due on a Roth IRA conversion. Yes, you can take money out of your Roth IRA. Generally there is no income tax due on a distribution, but if you are under age 59 ½ you may owe the 10% early distribution penalty. Here’s the way it works.

In order for all Roth distributions to be tax and penalty free, you must be at least 59 ½ AND have established any Roth IRA 5 years ago OR the distribution is due to death, disability, or is for a first-time home purchase.

It is more complicated if you are under age 59 ½. All of your Roth IRAs are treated as one big Roth IRA. You have to track three types of funds in your Roth IRAs: 1) your contributions, 2) your conversions, and 3) your earnings.

When you take a Roth distribution, your contributions are the first funds distributed - even if they are in a different account from the one that makes the distribution. Contributions are distributed tax and penalty free.

When your contributions are gone, then you start on your converted amounts; first in, first out. Each Roth conversion has its own 5-year holding period. If the funds are distributed before the 5 years are up for that conversion and you are still under age 59 ½, then you have to pay the 10% penalty on the amount distributed. (If the funds were after-tax funds when they were converted, then there is no penalty.) This means that you could be under 59 ½ at the time of the distribution and not owe a penalty - if the Roth conversion was done more than 5 years ago.

When your contributions and conversions are gone, then you are taking distribution of the earnings on the Roth account. The earnings will be taxable and subject to the 10% early distribution penalty since you are under the age of 59 ½.

Those are the distribution rules in a nutshell. However, we do NOT recommend that you take funds from your Roth account to pay the income tax due on the conversion unless you absolutely have no other way to pay the tax. You will be reducing the amount you have available in retirement and you are losing all of the tax-free compounded interest on what you withdraw. It could be the difference between living comfortably and having to make tough choices about where to cut back on your expenses in retirement.


-By Beverly DeVeny and Jared Trexler

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