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With the waiver of RMDs for 2020 I have seen many posts about doing Roth conversions with the equivalent amount of money. I have a question about the 5-year Roth rule in terms of taxation on Roth earnings.

Consider this hypothetical: I converted TIRA to Roth IRA in 2015 in the amount of $10K. No contributions, no other conversions. Value is now $12K (i.e., $2k of earnings). Since the 5 year clock has already passed, I can withdraw the full $12K w/o any tax on the earnings (and, of course, w/o any tax on the conversion amount).

Now, suppose before withdrawing funds from RIRA, I convert an additional one dollar from TIRA into RIRA, bringing its value to $12,001 (assume no other earnings). A month after this one dollar conversion I decide to withdraw the entire amount of $12,001.

Question: Did the latest one dollar conversion reset the 5 year clock on ALL earnings, so that now the $2K of earnings becomes taxable? I ask this in the context of the IRS rule that aggregates all Roth IRA accounts of a given taxpayer, so that even if I opened a new account for the one dollar conversion, it would seem to have the same effect as converting the one dollar into the original RIRA account.

Related question: Is there any easy way to look at one’s RIRA account and determine when the latest conversion was made? I have my account with Fido, and I did not see any way, so I called. The response I got was that there is no direct way to just look at the RIRA account, and a year-by-year search of Form 5498 is needed to determine the latest year in which a conversion was made into the RIRA. Yikes!

I am asking these questions more out of concern for my beneficiaries than myself, since with the passage of SECURE, and its 10-year limit on emptying out IRAs and RIRAs, Roth IRAs are becoming more valuable for beneficiaries, and RIRA conversions might become more popular going forward, even w/o the RMD waiver in future years.

Appreciate in advance any insights on these and related issues.

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Re: Question on Roth 5 year rule

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Yes, this article by Ed Slottt hits the nail on the head. Thank you! I am a big fan of Ed Slott; I purchased several of his books over the past decade to learn about stretch IRAs. Now that stretch IRAs are a thing of the past, Ed Slott once again comes to the rescue for those of us thinking seriously about Roth IRA conversions.

One big source of confusion for me in reading IRS Pub 590-B (linked above in several responses)   is that it contains Figure 2-1, page 30, titled: Is the Distribution from Your Roth IRA a Qualified Distribution?

The first box in the figure (a flowchart) asks: “Has it been at least 5 years from the beginning of the year for which you first set up and *CONTRIBUTED* (emphasis added) to your Roth IRA?” A Yes answer leads to other boxes (qualifying events), for any one of which a Yes answer leads to the Roth distribution being qualified.

Apparently Ed Slott interprets the word “contributed” in a general sense of either having made a Roth IRA contribution or a Roth IRA conversion. I wish the IRS had taken the time to be a bit more precise in their flowchart by replacing the word “contributed” with a phrase such as “made a Roth IRA contribution or conversion.”

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Re: Question on Roth 5 year rule

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My understanding is the five year period begins with first contribution to the first Roth IRA account. A qualified distribution is:

It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit  https://www.irs.gov/pub/irs-pdf/p590b.pdf

Subsequent, contributions do not change the commencement date of the 5 year period. But if you transfer the Roth to another IRA provider or open Roth accounts at several providers they are not going to know or use the date of the first contribution. The problem arises when there is a withdrawal, the provider will issue IRS form 1099-R with Box 7 Distribution Code, Q for a qualified [meets the 5 year requirement] Roth distribution or J early distribution from a Roth.

Fidelity monthly statements show the Roth conversion in the TIRA and Roth sections and the Fidelity website should show the  history of the Roth account. I thought the monthly statements and IRS forms such as 5498 for many years are available on the Fidelity website.

You might want to review the relevant state income tax laws on Roth conversions and Roth distributions. I was surprised to learn that the original after tax contribution to a Roth is not taxable but the increase is fully taxable for my state.

 

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Re: Question on Roth 5 year rule

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Thank you for your prompt response. You frame your answer in terms of Roth *contributions*, but the IRS makes a distinction between contributions and *conversions*. As Michael Kitces points out:

“Unlike the 5-year rule for contributions, in the case of conversions, each conversion amount has its own 5-year time period (Treasury Regulation 1.408A-6, Q&A-5(c)), and thus with multiple conversions there may be multiple different 5-year periods underway at once.”

https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conver...

Thus, it is uncertain whether the current $1 conversion in the hypothetical above resets the clock for the previously qualified earnings. If that were true, I would rephrase it as “poisoning the well.”

In terms of Fido records, yes, I agree the 5498s are available; it just seems that real research is needed to answer this type of question, vs. knowing status of investments in a taxable account, where all the info you need for tax purposes is available directly by clicking a given holding.

Finally, and w/o attempting to pry, I am curious what state(s) tax qualified Roth earnings?

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Re: Question on Roth 5 year rule

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A separate 5-year period applies to each Roth conversion. A later conversion does not reset the clock of previous conversions.

If a distribution taken from a Roth IRA includes money that according to the Ordering Rules for Distributions is from a Roth conversion done within the 5-year period after that conversion, then that part of the distribution is subject to a 10% addition tax on early distributions, unless an exception applies, such as being at least 59-1/2 years old.

The part of a distribution attributable to earnings may be subject to income tax and a 10% additional tax on early distributions, unless an exception applies.

For details, see the appropriate subsections of the Roth IRAs section of IRS Publication 590-B (Distributions from Individual Retirement Arrangements (IRAs)), which BlueBike88a provided a link for in a previous post.

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Re: Question on Roth 5 year rule

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Thanks for the info and for including links to IRS pubs. I was familiar with the fact that each conversion has its own 5 year clock and that a later conversion does not reset the clock of earlier conversions.

What I was hoping to drill down on was whether *earnings* are viewed as a single global entity across all of a given person’s RIRAs, and therefore, whether a new conversion resets the clock for *all* earnings, vs. whether there is a more granular way to somehow associate earnings with a given conversion year.

I am losing hope that there is a way to have this more granular view of earnings. In the event that I do future RIRA conversions, I will instruct my beneficiaries to refrain from withdrawing more than the sum total of my conversion amounts for at least five years, as a way to avoid taxation on earnings. They will not have to worry about the penalty associated with being under 59.5 years old by virtue of having inherited the RIRA.

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Re: Question on Roth 5 year rule

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If the inherited Roth consisted of conversions and >5-year-old of contributions, there is no tax on withdraws at all per M. Kitces in the link above: "As death is an exception to the early withdrawal penalty, any beneficiaries taking distributions from a Roth IRA will always enjoy penalty-free treatment (regardless of whether it’s principal or earnings, and regardless of whether the 5-year rule for conversions has been met or not). On the other hand, death does not eliminate the 5-year contribution rule for earnings to be tax-free! ".  

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Re: Question on Roth 5 year rule

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An article by Ed Slott (https://www.investmentnews.com/the-most-misunderstood-roth-conversion-tax-rule-2-170358) states, "The second five-year Roth clock deals with tax-free earnings. This holding period starts when the first Roth IRA account is established and does not restart for each Roth IRA contribution or conversion." 

It's worth a read. Ed Slott is often featured on M* so he's credible.

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Re: Question on Roth 5 year rule

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Yes, this article by Ed Slottt hits the nail on the head. Thank you! I am a big fan of Ed Slott; I purchased several of his books over the past decade to learn about stretch IRAs. Now that stretch IRAs are a thing of the past, Ed Slott once again comes to the rescue for those of us thinking seriously about Roth IRA conversions.

One big source of confusion for me in reading IRS Pub 590-B (linked above in several responses)   is that it contains Figure 2-1, page 30, titled: Is the Distribution from Your Roth IRA a Qualified Distribution?

The first box in the figure (a flowchart) asks: “Has it been at least 5 years from the beginning of the year for which you first set up and *CONTRIBUTED* (emphasis added) to your Roth IRA?” A Yes answer leads to other boxes (qualifying events), for any one of which a Yes answer leads to the Roth distribution being qualified.

Apparently Ed Slott interprets the word “contributed” in a general sense of either having made a Roth IRA contribution or a Roth IRA conversion. I wish the IRS had taken the time to be a bit more precise in their flowchart by replacing the word “contributed” with a phrase such as “made a Roth IRA contribution or conversion.”

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Re: Question on Roth 5 year rule

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@kalman wrote:

I am losing hope that there is a way to have this more granular view of earnings. In the event that I do future RIRA conversions, I will instruct my beneficiaries to refrain from withdrawing more than the sum total of my conversion amounts for at least five years, as a way to avoid taxation on earnings. They will not have to worry about the penalty associated with being under 59.5 years old by virtue of having inherited the RIRA.


As far a I can tell, there is nothing in IRS Publication 590-B or the instructions for tax forms used when a distribution is taken from a Roth IRA that treats the earnings of Roth IRAs differently depending on whether there has been a Roth conversion in the past 5 years. If a distribution is a qualified distribution, then the earnings are not taxed, otherwise they are taxed.

One condition for a distribution to be qualified is that it is made after the 5-year period beginning with the first taxable year for which a contribution (regular contribution; conversion contribution from traditional, SEP, or SIMPLE IRA; rollover contribution from a qualified plan) was made to a Roth IRA set up for the owner of the IRA.

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