Early withdrawal and qualified distributions

[Guest cornelio]

I made my first contribution to my Roth IRA in 1998 and made succeeding contributions since then. Let us say the total cumulative contribution was $15,000 until the end of 2001. Because the stock market has been declining since Dec 1999, the final value of the Roth IRA, by the beginning of 2002, was $10,000 -- a decline in value of $5,000, from the cumulative contribution.

Kindly help me clarify the following:

1) Is 2002 considered the 5th Year (if the first contribution was in 1998) of the Roth IRA? or is the 5th year in 2003?

2) If an early withdrawal in 2002, was made for the total balance of $10,000 (note that the cumulative actual contribution was $15,000 up to the end of December 2001 -- a loss in value of $5,000), please respond to the following (separate but related questions):

2a) If 2002 is considered the 5th Year of the Roth IRA, will the withdrawal in 2002 be considered a qualified distribution? If so, will the total amount ($10,000) be tax free, if the total cumulative contribution was $15,000 (i.e., a loss in value of $5,000)?

2b) If 2002 is considered only the 4th of the Roth IRA, the withdrawal in 2002 will not be a qualified distribution. If so, how much of the total amount of ($10,000) withdrawn be taxable, if the total cumulative contribution was $15,000 (i.e., a lost in value of $5,000)? How much will be subject to the 10% penalty?

Thanks!

Cornelio

[Appleby]

1. The fifth year is 2003

2. A “qualified distribution” cannot b take before 2003. Your first qualified distribution could be take January 1,2003

3. You may withdraw IRA participant contributions anytime (even the day after you make the contribution), without tax and penalty.

4. You would early distribution penalty only if you had earnings on the IRA contributions you deposited.

You would pay tax only if the distribution was not qualified and your distribution included earnings. The taxes would be due on the earnings.

See post at the following URL for additional information

http://benefitslink.com/boards/index.php?showtopic=19127

[Guest cornelio]

Mr. Appleby,

Thanks for the prompt reply. For some reason, when I click on the link you provided, my browser states that the URL (link) "cannot be found".

I just need more clarification on your 4th point, if you would be so kind. You stated:

"4. You would [have an] early distribution penalty only if you had earnings on the IRA contributions you deposited. You would pay tax only if the distribution was not qualified and your distribution included earnings. The taxes would be due on the earnings."

Summarizing the information I provided in the initial post:

Total cumulative contribution: $15,000 (since 1998)

Total net amount of Roth Account by 31 December 2001: $10,000

Net Loss by the end of 31 December 2001: ($5,000)

Assume all of the Roth IRA account balance was withdrawn 1 January, 2002:

$10,000 (i.e., $0 balance by 2 Jan 2002)

Because there were mutual funds in the account, technically there were distributed earnings, from 1998 to the end of December 31, 2001. Let us assume, hypothetically that there was a cumulative earnings of $1,000 since the account was opened in 1998 until December 31, 2001. However, please note that the net balance of the account was still $10,000 ($5,000 less than, or a loss compared with, the total cumulative contribution) by the end of Dec. 31, 2001 -- just before the total balance was withdrawn.

Based on these clarifications, kindly elaborate on your 4th point:

Will there be taxes (and penalties***) to be paid, on the cumulative earnings of $1,000 -- if there was a net loss of $5,000 -- since only $10,000 was realized from the total cumulative contribution of $15,000? [Assume also that there was only one and final withdrawal - essentially closing the account, or zero balance by 2 January 2002.]

Thanks.

Cornelio

________

***We shall take your first point here is correct, i.e., 2003 is the 5th year, so that the one and final withdrawal will be treated as an "early distribution". Thus, if there is "net earnings", the earnings will be taxable and there will also a 10% additional early withdrawal penalty on the "net earnings", if any.

[Appleby]

My apologies.

The correct URL is http://www.benefitslink.com/boards/index.p...ST&f=18&t=19127

[Appleby]

cornelio,

You say your total contribution is $15,000. However, as you were limited to $2,000 each year to 2001, this cannot be from just regular contribution. Did you convert assets from a traditional IRA to your Roth IRA? If so, what year did the conversion occur?

If you converted assets from your traditional IRA anytime after 1998, you may owe a 10 percent penalty of the converted assets, if they are distributed before five years after the conversion.

You have no earnings… because your balance is less than your contributions.

[Guest cornelio]

Dear Mr. Appleby,

The only regular Roth contribution ($2000) was done in 1998, the rest were traditional IRA to Roth conversions made in 1999.

If I understood you correctly (including your post from the other link), let me state the following to rephrase your statements (and kindly reply in the order mentioned below to avoid confusion):

(1) Since it is a long way before I will be 59&1/2 yo, all contributions will be considered "non-qualified" -- except under the stipulated exemptions?

If the aforementioned is true, then:

(2) Is the $2,000 (regular Roth) contributed in 1998 tax free, since it is principal? Is it subject to 10% additional tax penalty?

(3) Is the remaining $8,000 (Roth conversion from traditional IRA) contributed in 1999 tax free, since it is principal? [Note that during the 1999 conversion tax, the said $8,000 was already taxed as regular acccount.]

(4) If I understood you correctly, is the remaining $8,000 (Roth conversion from traditional IRA contributed in 1999) contributed in 1999) subject to 10% additional tax penalty?

(5) When it stipulates "10% additional tax (penalty)" for early distributions made within 5 years of the Roth conversions, does this mean that I owe penalty taxes of $800 (for the $8000)? And, possibly $200 (for the $2000 Roth contribution in 1998)?

(6)Or, do you declare the 10% "early withdrawal" penalty as income, to be taxed? I think the latter may be an incorrect interpretation of the law.]

Thanks again for your kind replies.

Cornelio

[Appleby]

Your comments ( copied and pasted) are in black

My responses in blue

1) since it is a long way before I will be 59 & 1/2 yo, all contributions will be considered "non-qualified" -- except under the stipulated exemptions?

Right…. a qualified distribution

must occur at least five years after the Roth IRA owner established and funded his/her first Roth IRA

and at least one of the following requirements must be met:

- you must be at least age 59 ½ when the distribution occurs

- you use the distribution towards the purchase or rebuilding of a first home

- the distribution occurs after you become disabled

-the assets are distributed to the your beneficiary after your death.

2)Is the $2,000 (regular Roth) contributed in 1998 tax free, since it is principal? Is it subject to 10% additional tax penalty?

A distribution of regular IRA participant contributions is always tax and penalty free.

(3) Is the remaining $8,000 (Roth conversion from traditional IRA) contributed in 1999 tax free, since it is principal? [Note that during the 1999 conversion tax, the said $8,000 was already taxed as regular acccount.]

. Yes, because you already paid taxes on this amount. It will , however be subjected to the 10 percent early withdrawal penalty, unless you meet an exception

(4) If I understood you correctly, is the remaining $8,000 (Roth conversion from traditional IRA contributed in 1999) contributed in 1999) subject to 10% additional tax penalty?

Yes

(5) When it stipulates "10% additional tax (penalty)" for early distributions made within 5 years of the Roth conversions, does this mean that I owe penalty taxes of $800 (for the $8000)?

Yes

And, possibly $200 (for the $2000 Roth contribution in 1998)?

No

(6)Or, do you declare the 10% "early withdrawal" penalty as income, to be taxed?

No . This is not income, merely a penalty on an early withdrawal.

[Guest Derelict]

Ordering Rules would help out here:

Roth distributions will come out like this-

1) Contributions

2) Conversions (FIFO)

3) Earnings

The first 2k you take out will be your contribution from 98 which will not be taxed or 'penalized'.

The next amounts you take out will be conversion monies from the '99 conversion which will still fall into a 5 year "recapture" rule, which the 10% will apply since it was taken within 5 years of the conversion.

Anything beyond these amounts would have been earnings, taxable and 10% 'penalty'

[Guest cornelio]

Thanks Mr. Appleby and Derelict,

I am trying to beat the deadline here. It is a matter of maximizing my "conversions" but still minimize taxes and penalties (don't ask why or how come; too complicated to explain the situation). The $$$ values given above were hypothetical just to simplify the discussion -- most of the pertinent records are in another state. [ I am visiting in Boston since January.]

I will comeback some other day to recap, to make sure that I understood your points correctly.

Again, I am very grateful for all your help.

Cornelio