Roth conversion timetable

[Guest jhellyar]

I coverted my IRA to a ROTH IRA in Dec 1998 with 4 years to pay taxes. When may I draw from it? I know it must be in existance for 5 years but when do I start counting?

[JAMES PATRICK]

The five year time frame starts on January 1 of the year a Conversion was made , or in your case January 1,1998.

You can withdraw tax free and penalty free on January 1,2003 if you are (will be) 59 1/2.

[Guest franky]

You can withdraw the 98 conversion anytime after 2002 tax- and penalty-free, even if you are not yet 59½. Only the earnings would be taxed and possibly penalized if you are not yet 59½, disabled, or first-home buyer.

[JAMES PATRICK]

I disagree with Franky. If you withdraw the conversion amount after 5 years and you are not 59 1/2,disabled,a beneficiary or First time home buyer, than it is NOT a qualified distribution and would then be subject to the 10% penalty unless one of the other exceptions to the 10% penalty rule applied.

Check PUB 590 under Roth IRA's and read page 43 : Additional tax on early distributions.

[Guest franky]

James, I respectfully disagree with you. The whole issue of whether a distribution is qualified or not refers ONLY to the distribution of earnings. The distribution of contributions and conversions are always tax- and penalty-free. The only exception is conversion dollars that are withdrawn within 5-year period starting with year of conversion -- then 10% penalty may apply (If no other exception exists). The only time conversion could be taxable was under the acceleration rule for conversions that were taxed under four-year spread and distribution was taken during first three years. Don't feel bad, James, yours is a very common misconception.

[BPickerCPA]

Franky is correct. Penalties only apply to withdrawal of earnings, once five years has passed since the conversion.

[Guest jhellyar]

After 5 years have passed from the conversion date (Dec 1998) my I withdraw any amount of money. I am 70. I didn't think there were any penalties after 59 1/2 aand how do you define "earnings"?

[JAMES PATRICK]

Franky and Barry are correct, no penalties after 5 years on conversion amounts.

Earnings are the monies your initial conversion had added to it.

If your initial conversion was $10,000 and the value of the acount is now $11,250 then your "earnings" are $1,250. If your value is less than $10,000 than you have no earnings.

To get back to your original question, you can withdraw All your funds from this Roth on January 1, 2003 with NO penalties or taxes. I would suggest however that if you have taxable savings accounts that they should be tapped before the Roth account.

[John G]

This is an old refrain from me.... but STOP. Think twice before taping into a Roth.

Just because something is allowed does not mean it is smart. It can be allowed and tempting and still be financial foolish in the long run. {told by a fellow who was once seduced by a ten year averaging on a lump distribution that subsequently cost many thousands of dollars.. and counting... in taxes}

The Roth is an extraordinary tax shelter with very generous rules governing distributions and estate planning. Before you tap into it, you should consider a wide range of alternatives: not spending the money, bridge loans, home equity loans, borrowing against other holdings in a brokerage, intra-family loans, refinancing, selling something, negotiating an scheduled payout, asking for a bonus/raise, etc.

The whole point of a tax shelter is to maximize the dollars sheltered and the time sheltered.

Even in retirement, the answer of what assets to tap first can be complicated. Often you want to consume the Roth last, but the optimal solution for you will be a function of your likely income stream, future tax rates, pension plan, other assets, etc.

[Guest jhellyar]

Thanks for your excellent advice. I'm really just trying to get the rules of Roth straight and I have no intention of touching this investment in the foreseeable future if ever. Next question..I know a Roth passes directly to my two children, but does it become part of my estate? and consequently, taxeable to my heirs??

[John G]

Your designation of benefitiaries is the first factor that determines who receives the IRA or Roth. Most custodians want a benefitiary declared. You can have primary benefitiaries and back-ups, and you can give percent allocations.

For example, you can declare your wife as primary and kids as backup. When you die, you wife could decline being primary and the IRA would be given to your kids. Or, she could decide she needs the funds and keep the funds.

Estate rules are in flux, but right now the amount of the IRA is counted as part of the overall estate. Don't die this year... next year the initial exempt part of an estate bumps up! If you are below the estate tax thresholds, then the Roth would pass to your heirs and have no income or estate taxes owed.

The problem with the estate tax threshold is that it is now catching too many families. Historically, estate taxes were imposed on the super wealthy, but the tax threshold did not float with inflation and with 401ks, ESOPs, IRAs and rises in home values more folks are getting caught and complaining about the fairness issue (but not Buffett or the senior Gates). I think the WSJ talked about only 1.5% of families in the late 1990s triggered estate taxes, but that number could easily climb to 10% in this decade. The republicans would like to completely eliminate "death taxes" and "double taxation". From a practical matter, Congress can eliminate 80% of the families that might owe estate taxes but only lose 20% of the revenue.... which is why something less than a total elimination is likely. I would suspect that in a few years estate taxes will only apply to estates above $5 or $10 million.