I'm 75 years old, and did my first traditional IRA to Roth IRA conversion on 12/31/2021. I know there is a 5 year rule regarding when I can access the funds I converted -- but I think, since I'm over 59 1/2, that 5 year rule does not apply to me -- and I need to verify that. Is it true, I could access that Roth money penalty-free tomorrow if I wanted to, since I did the conversion when I was well over 59 1/2?
There are two 5 year rules for Roth IRAs. It's all in here.
https://www.irs.gov/publications/p590b#en_US_2020_publink1000231065
1. To be a "qualified" distribution, the payment must be made after you reach age 59-1/2 (or certain other reasons), AND after the fifth tax year in which you first opened a Roth IRA.
If this is your first ever Roth IRA account, opened 12/31/2021, then the 5 tax-year period runs from 2021 through 2025. Your withdrawals will not be qualified until 1/1/2026.
This 5 year rule is satisfied by any Roth IRA, so if you had opened a previous Roth IRA in the past, you may have already satisfied this 5 year rule and your withdrawals would be qualified even if you withdrew them tomorrow.
2. There is a second 5 year rule for conversions. Each conversion has its own 5 year waiting period, separate from the overall 5 year waiting period for owning a Roth IRA. Again, you can withdraw your basis but not your earnings. However, if the withdrawal is otherwise qualified, the penalty for withdrawing earnings from a conversion is only the 10% penalty for early withdrawal, and that does not apply if you are over age 59-1/2.
The bottom line is that
Using your suggestion, let’s convert 100 shares of McDonald stock worth $26,800 on 12/31/2021, and convert 100 shares of AT&T worth $2600 on 7/1/2022. Your conversion basis is $29,400.
Let's look at 2 scenarios.
On June 30, 2025, the balance is $34,000 (assuming 5% per year) and you need to withdraw $30,000. Using the ordering rules:
Or, suppose you want to withdraw the entire account balance on January 2, 2026, and the balance is about $35,000. Now, the entire withdrawal is qualified because you are over age 59-1/2, and you meet the general 5 year rule. Using the ordering rules:
The 5 year conversion rule affects the earnings only and not your original contributions. You are exempt from the penalty on the distributions however the earnings can be subject to federal taxes. Just don't invade the earnings until 1/1/25 and all is good.
Thanks Critter-3. Not sure we're exactly on the same page here. I'm talking about a ROTH conversion. Not a contribution of any kind -- whether to a tradional IRA or a ROTH.
As you mentioned Federal taxes might be due on the earnings, I kind of think you are thinking about a traditional IRA. Once in the Roth, there should be no taxes due on anything -- as long as I follow the rules...
All that said: I'm trying to find out if I'm exempt from the 5 year rule related to Roth conversions, namely that each time I make my first Roth conversion of a year I start the clock on a new 5 year waiting period. Ex:
I convert 100 shares of McDonalds to a Roth in 2021.
I convert 100 shares of AT&T to a Roth in 2022.
According to my understanding of the 5 year rule for conversions, if I don't want a 10% penalty, I must wait till 2026 to get to the McDonalds (stock or earnings), and 2027 to get to the AT&T (stock or earnings).
HOWEVER -- I believe -- since I am 75 (i.e. over 59 1/2), and just making my first Roth conversion -- that I am exempt from any of these 5 year rules, meaning I can take anything out of my Roth the day after I put it in if I want to, (stock or earnings), penalty free. THIS is what I'm trying to verify.
@Critter-3 wrote:
The 5 year conversion rule affects the earnings only and not your original contributions. You are exempt from the penalty on the distributions however the earnings can be subject to federal taxes. Just don't invade the earnings until 1/1/25 and all is good.
Not quite. There are two 5 year rules. The 5 year rule about conversions only applies if the account owner is under age 59-1/2. The general 5 year rule applies to everyone.
There are two 5 year rules for Roth IRAs. It's all in here.
https://www.irs.gov/publications/p590b#en_US_2020_publink1000231065
1. To be a "qualified" distribution, the payment must be made after you reach age 59-1/2 (or certain other reasons), AND after the fifth tax year in which you first opened a Roth IRA.
If this is your first ever Roth IRA account, opened 12/31/2021, then the 5 tax-year period runs from 2021 through 2025. Your withdrawals will not be qualified until 1/1/2026.
This 5 year rule is satisfied by any Roth IRA, so if you had opened a previous Roth IRA in the past, you may have already satisfied this 5 year rule and your withdrawals would be qualified even if you withdrew them tomorrow.
2. There is a second 5 year rule for conversions. Each conversion has its own 5 year waiting period, separate from the overall 5 year waiting period for owning a Roth IRA. Again, you can withdraw your basis but not your earnings. However, if the withdrawal is otherwise qualified, the penalty for withdrawing earnings from a conversion is only the 10% penalty for early withdrawal, and that does not apply if you are over age 59-1/2.
The bottom line is that
Using your suggestion, let’s convert 100 shares of McDonald stock worth $26,800 on 12/31/2021, and convert 100 shares of AT&T worth $2600 on 7/1/2022. Your conversion basis is $29,400.
Let's look at 2 scenarios.
On June 30, 2025, the balance is $34,000 (assuming 5% per year) and you need to withdraw $30,000. Using the ordering rules:
Or, suppose you want to withdraw the entire account balance on January 2, 2026, and the balance is about $35,000. Now, the entire withdrawal is qualified because you are over age 59-1/2, and you meet the general 5 year rule. Using the ordering rules:
(Boy, I had a hard time getting back into here! All kinds of problems trying to log-in...Not sure how I finally made it, but anyway, here I am)...
Thanks, Opus 17...
This is a wealth of info, and I appreciate it. I'm mainly focused right now on just this part of your reply:
The bottom line is that
Number 3 is what I'm interested in. And I think you meant to say"the 10% penalty for early distributions..." rather than 10% tax for early conversions"... did you not?
(As I am converting from a traditional IRA to a Roth, I pay the tax when it leaves the traditional IRA. Once in the Roth, there should be no more tax, ever. It's a 10% penalty on breaking this 5 year rule, that I'm concerned with).
Am I interpreting correctly that, since I made my first Roth conversion at age 75 (well past 59 1/2), that I can take any (or all) of the money out of that Roth at any time (even the very next day after I did the conversion, if I wanted to), with no penalty?
Another way to ask this, taking this from your reply...
"If this is your first ever Roth IRA account, opened 12/31/2021, then the 5 tax-year period runs from 2021 through 2025. Your withdrawals will not be qualified until 1/1/2026".
Does this 5 year period still apply if I am over 59 1/2 when I do this first conversion?
@jefals wrote:
Am I interpreting correctly that, since I made my first Roth conversion at age 75 (well past 59 1/2), that I can take any (or all) of the money out of that Roth at any time (even the very next day after I did the conversion, if I wanted to), with no penalty?
Mostly. However, if you withdraw earnings in less than 5 years, it will not be "qualified" and you will pay regular income tax on the earnings, even though you don't pay income tax on the converted principal. And that's where the ordering rules come into play.
Early and qualified are two different things, even though they are very similar and it's easy to get confused.
Any withdrawal you make before 1/1/2026 will be both early and non-qualified. The "price" for making a non-qualified withdrawal is paying regular income tax on the earnings but not the principal. There is no penalty for you for making an early withdrawal because you are over 59-1/2. Any withdrawal you make after 1/1/2026 will be qualified, so withdrawals of earnings will be tax-free. And even if your withdrawals are considered "early" due to the separate clock that runs for each conversion, there is no penalty at your age.
Basically, this relates to the difference between an IRA and a Roth IRA. Suppose I'm 50, and I want to withdraw from my regular IRA. I pay income tax plus a penalty. If there was not a separate 5 year clock on each conversion, then I could convert my IRA to a Roth, pay the income tax, then withdraw from the Roth tax-free and save 10%. That's why the 10% penalty is applied to conversions less than 5 years old, and it's also why that penalty is not applied if you are over 59-1/2, because you would not pay a penalty if you simply withdrew the money from the regular IRA instead.
Got it. Thanks Opus.
Ok, then, so as long as I don't take anything out till 1/1/2026, I'm "home-free". (Even tho it's a "5 year rule, it's more like a 4 year rule for me, since I did the conversion 12/31/21)!
I converted dividend paying stocks -- not cash, which is what I plan to do with my future conversions. And, since I do now want to wait till 1/1/2026 to avoid the penalty, it would seem to make sense for me to try and convert my least productive stocks -- the ones that pay the lowest dividends -- for the time being, so that I'll still have access to more cash while I'm waiting for that 5 year clock....
@jefals wrote:
Got it. Thanks Opus.
Ok, then, so as long as I don't take anything out till 1/1/2026, I'm "home-free". (Even tho it's a "5 year rule, it's more like a 4 year rule for me, since I did the conversion 12/31/21)!
I converted dividend paying stocks -- not cash, which is what I plan to do with my future conversions. And, since I do now want to wait till 1/1/2026 to avoid the penalty, it would seem to make sense for me to try and convert my least productive stocks -- the ones that pay the lowest dividends -- for the time being, so that I'll still have access to more cash while I'm waiting for that 5 year clock....
Again, even before 1/1/26, you only pay tax on earnings, if you withdraw earnings. Using the ordering rules, your conversion basis is withdrawn first, so would not pay income tax on withdrawals before 1/1/26 unless you tapped out your conversion basis and dipped into the value that your stocks have earned since the conversion.
Just "chewing over" this part a little....
Any withdrawal you make before 1/1/2026 will be both early and non-qualified. The "price" for making a non-qualified withdrawal is paying regular income tax on the earnings but not the principal. There is no penalty for you for making an early withdrawal because you are over 59-1/2. Any withdrawal you make after 1/1/2026 will be qualified, so withdrawals of earnings will be tax-free. And even if your withdrawals are considered "early" due to the separate clock that runs for each conversion, there is no penalty at your age.
So, then, let's see if I got this:
The 10% penalty is related to the separate clocks. ( A separate clock for each year I do a conversion). And I avoid this penalty since I'm over 59 1/2.
The "tax on earnings" is based only on the first clock. No matter when I do conversions, as long as I don't touch the earnings till 2026, I'm tax free from then on out.
---
Correct?
@jefals wrote:
So, then, let's see if I got this:
The 10% penalty is related to the separate clocks. ( A separate clock for each year I do a conversion). And I avoid this penalty since I'm over 59 1/2.
The "tax on earnings" is based only on the first clock. No matter when I do conversions, as long as I don't touch the earnings till 2026, I'm tax free from then on out.
---
Correct?
Yes.
a) If you invest the Roth as intended, for growth, Why would you want to take earnings out ??
b) it's unlikely the IRS is going to audit you whatever you do..
Hi fanfare,
Yeah, at this point, I'm way past the "growth" phase. Now retired, I live on social security and dividends. So I'll be taking those dividends out.
I wish Roth IRAs had been available when I started investing back in the 70s. They didn't come around till the 90s, when I was pretty dug into my traditional IRA's and not thinking about things like MRDs. The MRDs I'm looking at -- now, and down the road -- are kinda shocking. That's one of the main reasons I'm converting from the traditional IRAs to the Roth. The other is the advantages to the kids when they get the money tax free.
Hey, when I ask for tax rules, "you're unlikely to get audited" -- USUALLY is not the kinda advice I'm looking for! 🙂
Opus! Thanks for the details and helping us to understand the "5 Year Rule" x 2! Previously we thought that being over 59 1/2 put us in the clear - first Roth was in 1998. Even after checking with our tax professional!
Reading your post filled in the blanks that I was intuiting! Something just wasn't clear, no matter how many times we read the IRS publication 590B.
To add another layer: As newly retired and paying attention to all the brackets that can affect taxation, including the Income Related Adjustment for Medicare payments, I am wondering if a non qualified withdrawal (within the 5 year time from a particular roth conversion (basis) is added to the MAGI from which the IRMAA is derived?
Age: over 65.
in January 2022 cashed out a roth part converted in 2017 (6500.00) and part (another 6500) was converted in 2019. (all was originally a non deductible IRA)
income was under $120.00.
I think I understand how this will work for this year... feel free to break it down however, for confirmation!
We are planning on doing more roth conversions going forward and want to know if we will need to consider money that hasn't been converted for 5 plus years as income AGI MAGI when figuring out how much we want to convert in a year without going into a higher bracket.
Thanks again.
@Nan2C wrote:
To add another layer: As newly retired and paying attention to all the brackets that can affect taxation, including the Income Related Adjustment for Medicare payments, I am wondering if a non qualified withdrawal (within the 5 year time from a particular roth conversion (basis) is added to the MAGI from which the IRMAA is derived?
Age: over 65.
in January 2022 cashed out a roth part converted in 2017 (6500.00) and part (another 6500) was converted in 2019. (all was originally a non deductible IRA)
income was under $120.00.
All your withdrawals are tax free over age 59-1/2. That's the simple answer.
The medium-complex answer is that:
1. Withdrawal of contributions are never taxed.
2. Withdrawal of a non-qualified conversion (less than 5 years per conversion) is not subject to income tax, but is subject to a 10% early withdrawal penalty.
2a. But the 10% early withdrawal penalty never applies if you are over age 59-1/2. So anyone over age 59-1/2 can ignore the separate 5 year clock for each conversion.
3. Withdrawal of earnings is subject to income tax if the account is open less than 5 years or you are under age 59-1/2.
3a. In your case, the account is opened more than 5 years and you are over 60, so earning are never taxed.
So for your specific situation, all your Roth withdrawals are never taxed.
A withdrawal from a Roth IRA is never a MAGI adjustment for IRMAA.
However, because a conversion from a regular IRA to a Roth IRA creates taxable income, the conversion IS income included in MAGI for IRMAA in the year you do the conversion.
So short answer, it is IRMAA income when you do the traditional to Roth conversion, but it is not IRMAA income when you withdraw from the Roth, regardless of the 5 year rule for conversions.
Thank you for your reply.
So in our case, the 2019 non deductible conversion to a roth is ? a non qualified roth distribution we cashed out in Jan 2022?
I am almost clear
@Nan2C wrote:
Thank you for your reply.
So in our case, the 2019 non deductible conversion to a roth is ? a non qualified roth distribution we cashed out in Jan 2022?
I am almost clear
There will be no tax on your January 2022 withdrawal.
I do understand there will be no Federal Income Tax, I am more concerned with trying to understand Qualified vs Non Qualified and how that will affect us in future years If we need to take any roth distributions including income / within 5 years of a conversion.
I don't think I asked that question clearly. So do I understand that to mean, that after 59 1/2 all withdrawals from Roth Iras even if converted within the last 5 years are considered Qualified? (therefore- Not incurring any tax and - not affecting MAGI?)
I am a bit unclear about Qualified and non Qualified. Does Non Qualified will affect MAGI / IRMAA? It sounds like if we won't incur any taxes the Distribution we made would be classified as Qualified? I am just not sure
Thank you for your patience with me!
It depends. Let me give some basics about Roth. When you open a Roth and stays open for five years, that is referred to a five-year holding period. What this means is if you have earnings within the Roth, if you withdraw within the five-year holding period you will be taxed on the earnings. In addition to being taxed, you will suffer an early withdrawal penalty if you are under 59 1/2. This would be an example of a non-qualified distribution because the five-year holding period has not been met.
A qualified distribution from a Roth IRA is tax-free and penalty-free, provided that the five-year aging requirement has been satisfied and one of the following conditions is met:
Just keep it simple. Over the age of 59 1/2, Roth IRA withdrawal‘s do not add to your MAGI.
What I should have made clear, and may have gotten a bit turned around on myself, is that Roth IRA withdrawals can have two characteristics. They can be qualified (or not) and they can be early (or not). All of your withdrawals are qualified at this point, because your account is more than five years old and you are over age 59 1/2. If you withdraw a conversion in less than 5 years, that would be early. But the only tax issue for an early withdrawal is the 10% additional penalty, and that is automatically excluded if you are over 59 1/2. So even though some of your withdrawals might technically be early, they are all qualified, and you will not pay any income tax or penalties on any withdrawals from any Roth IRA for the rest of your life and they don’t add to your MAGI.
However, you also talked about doing new conversions of traditional IRA to Roth IRA, and that will raise your MAGI for the year you do the conversion.