ROTH conversions, 5 year rule

[hunzoli]

If one has multiple ROTH IRA accounts, does IRS handle them as just having one account? In detail: I have an "old" over 5 years Roth Ira with substantial growth over the years. And now, I want to create more separate Roth Ira accounts to see easily my finances. I convert traditional IRAs to new ROTH accounts, which are long term investments. I am not going to touch them for over five years. I know the Ordering Rule of IRS, but it is not clear in this case. Will IRS handle the multiple Roth accounts one by one? If another account "matures" over 5 years old, will I be able to use it just like my "old" Roth account? In this sense, does it make sense to have multiple separate Roth accounts? Thanks in advance for clarification. And, can Turbotax handle this kind of Tax case? Regards, Zoltan

[Click]

Roth IRA accounts are all one Roth IRA account as far as the IRS is concerned. Similarly for IRA accounts (but not 401(k) accounts).

The 5-year clock you are referring to starts Jan 1 of the year you put your first dollar into ANY Roth IRA account, even if you closed that account decades ago. If that occurred for you at least five years ago, and you are older than 59 1/2, there are no five year rules for you to worry about any more.

[hunzoli]

Hi Click,

THanks for the quick reply. I understand that having a Roth IRA over five years, covers the five year requirement for all Roth IRAs, and being over 59 1/2 old, as far as the principal goes, meaning contribution and conversions. But, the other five years rulke is on earnings. The distribution from earning portion to be qualified, the account has to be over five years old. This is my understanding. Am I missing something here?  Due to IRS' ordering rule, I thought it is cleaner if I have separate Roth accounts for each conversion. Then, it is clear where money is withdrawn from, easier to document. Is it a valid approach, or unnecessary one?

[Click]

That seems to be a common misconception. Again, the IRS views all your Roth IRA accounts as if it were one account. It doesn't care about account boundaries. Same is true for IRA accounts .. they are all one. (however, not true for 401(k) accounts).

The OTHER 5-year rule on conversions and penalty for withdrawing principal does start a new clock for each conversion. However, the 5-year-rule on conversions does not apply to those over 59 1/2.

https://www.schwab.com/learn/story/what-to-know-about-five-year-rule-roths

[hunzoli]

Thanks again. My major confusion is not with the principal portion, but the gain, which is generated. YEs, I could take the principal as I wish once I paid the tax. Being over 59 1/2, not tax, no penalty on withdrawal. But, there is a five years clock ticking for the gain. As far as I know, that portion would be taxed, and also incur a 10% penalty.

How about this?

[Click]

I shouldn't have said principle. 

"After age 59½, you can withdraw converted funds without a 10% penalty. But remember, the five-year contribution rule (mentioned above) still applies—if that rule hasn't been met, taxes may apply for the earnings portion of the withdrawal." However, if you've put a dollar in any Roth IRA five years ago or move, you have satisfied the contribution rule.

It can't be any simpler than this:

If you are 59 1/2 or older, AND you put a dollar into any Roth IRA account five years ago or more, then you have no five year rules to think about. Not on principal, conversions, earnings ... nothing. No five-year rule for you.

[hunzoli]

I have a different understanding: over 59 1/2 there is no 5 year rule if the Roth account is over 5 years old. A conversion made in this age is also tax freely distributable without penalty, since it is already taxed at the conversion. However, the earning portion achieved with this conversion is not qualified distribution before the 5 year hold period, it is taxed plus 10% penalty. Just the earning, following IRS' Ordering Rule. And, each conversion starts its own 5 year holding period on the portion, namely the earnings. It comes in play only if the distribution is over the principal.  This is my understanding, and here is what I found, -it makes sense:

"Does the five-year rule apply to Roth IRA owners older than age 59½?

Short answer—yes! The five-year rule remains (very) relevant once the account owner attains age 59½. Why? This five-year holding period must still be satisfied if a Roth IRA owner wants tax-free distributions of earnings. As mentioned, a qualified distribution from a Roth IRA requires the owner to be age 59½ and satisfy the five-year holding period.

Example: Maria, age 75, converts $200,000 from her SEP-IRA to a Roth IRA in 2021. In 2024, when her Roth IRA has grown to $225,000, she takes a full distribution thinking it will be tax-free. The first $200,000 will be distributed tax-free. This is because Maria paid taxes on this amount when she converted such funds in 2021. Furthermore, $25,000 (earnings) will also be distributed penalty-free because Maria is over age 59½. However, the $25,000 (earnings) is not a qualified distribution and will therefore be taxable because the five-year rule has not been satisfied. Maria would need to wait until January 1, 2026, to satisfy the five-year holding period and therefore qualify for tax-free treatment."

Therefore to keep things separate, I thought it would be better to do each conversion to a new ROTH account. Otherwise, it would be difficult to define where the distribution comes from, which part is principal, which is earning. Don't I understand something right?

[Click]

What you found on Lord Abbett's site (whoever that is) is misleading. In the example cited, you'd have to make the assumption that Maria's Roth conversion was the first time she ever had a Roth IRA account. With that assumption, the scenario is true. Any explanation of the five-year-rules just adds to confusion if it doesn't clearly distinguish between the two different rules.

You might want to look at https://www.fidelity.com/learning-center/personal-finance/retirement/roth-ira-5-year-rule. Note they say (emphasis added). If you read the first long sentence and stop, it does sound like, yes, you have to worry about earnings after a conversion. But then read the next sentence (emphasis added).

Roth conversions and the 5-year rule

The Internal Revenue Service (IRS) requires a waiting period of 5 years before withdrawing balances converted from a traditional IRA to a Roth IRA, or you may pay a 10% early withdrawal penalty on the conversion amount in addition to the income taxes you pay in the tax year of your conversion. There are a variety of exemptions to this penalty, however, including death, disability, and turning age 59½.