Roth withdrawal after 2010 conversion

[Jim Norman]

An employee terminates employment in 2010 and takes a total distribution of her 401(k) account, apparently paid as a direct rollover to an IRA and immediately converted to a Roth. So far so good. The income from the conversion will be recognized 50% in 2011 and 50% in 2012.

Now here’s the twist. After converting to a Roth, she withdrew all the money from the Roth. Does this change the way the Roth conversion is taxed? The Roth withdrawal is not a “qualified” withdrawal because she did not wait 5 years, but this only affects the taxation of any earnings. Principal can always be withdrawn from a Roth without additional tax.

So, did she just figure out a way to take a 100% distribution of her 401(k) in 2010 and pay the taxes over 2011 and 2012?

[GMK]

After a quick search (meaning I didn't research it):

http://www.irs.gov/publications/p590/ch02.html

Later withdrawals from Roth IRA. If you include the taxable part of a 2010 conversion in equal amounts over the 2-year period (2011 and 2012) and in 2010 you withdraw from the Roth IRA any amount allocable to the taxable part of the conversion, you will generally have to include in income for 2010 the part of the withdrawal made during the year that is allocable to the taxable part of the conversion.

Any amount allocable to the conversion that is included in income in 2010 because of the distribution from the Roth IRA first reduces the taxable amount that is reportable in income in 2012. The taxable amount that is reportable in income in 2011 is reduced next. The most that can be included in income because of the withdrawal of a conversion amount for any one year is the total amount required to be included in income for 2011 and 2012 minus the amounts included in income in all preceding years in the period.

[Jim Norman]

Thank you much. Had a chance to research it this morning and also found Notice 2010-84 that states the same.