Hello, this is Greg Phelps, your host of the RetireWire blog and podcast, and what I wanted to discuss real quickly was, “will distributions from a Roth conversion be penalized?” And we’re not talking about ordinary income taxes, we’re talking about a Roth conversion amount—and let’s just use $10,000 as an example.
Real quickly the answer is if you’re over age 59 and a half, no, you will not be penalized on taking withdrawals from a Roth IRA that you converted from an IRA, a pretax IRA.
Now as we all know, the Roth IRA is a very, very powerful tool (almost as good as the Health Savings Account)because what we’re doing effectively is we’re taking money that is pre-tax and we’re paying taxes at the amounts that we’re okay with (up to certain tax brackets), that we’re comfortable with at these historically low tax rates, and we’re moving that into a Roth IRA that will be tax-free forever.
Now the question is if you are under age 59 and a half, will distributions from a Roth conversion be penalized? And the answer is, “well, maybe.” And I’m gonna explain to you why right now.
So first off, let’s talk about that IRA money that you’ve got. We’re going to take a distribution, we’re going to pay some tax, then we’re going to put it into a Roth IRA, now it will be tax-free forever, and that is year one.
Now let’s say that we’ve got multiple years we’re going to be doing this over. So we’ve got two, three, four, five, six, seven, eight, nine, let’s just use 10 years. So we did that in year one.
What the IRS does not want you to do is move this money from the IRA over to the Roth before age 59 and a half when it would be penalized if you were to pull it out of the IRA to avoid that 10% penalty. And just for the record, it is a 10% penalty plus ordinary income taxes from the conversion.
So the IRS does not want you to avoid that 10% penalty. So what they’re going to do is say, well, you’ve got to wait five years to withdraw that conversion before the penalty will go away.
So let’s say you’re actually age 53 in year one. So now you’ve got to basically wait that five years till you’re 58 in that point in time where you can actually avoid that distribution penalty of 10%. Now the other thing to keep in mind is that every conversion that you has its own five-year window.
So if you did this in year three, let’s just say for example, you now have to wait until the eighth year to distribute those monies without that penalty. However, there’s a little trick here.
At some point you’re going to hit 59 and a half at which point the IRA would have been penalty-free anyways. So in this case, you’re going to hit 59 and a half about there 6 to 7 years into the process if you started at age 53) and you can now take money out of a Roth IRA without that 10% distribution penalty.
And again, we’re not talking about the growth, we’re not talking about IRA contributions to a Roth IRA. We’re talking about a Roth conversion and the penalties that may apply if you were to withdraw funds from that Roth that was converted from an IRA before age 59 and a half.
So keep in mind that five-year rule, you’ve got to get that five years in there before you can withdraw funds from that conversion without the penalty.
Thank you very much. Don’t forget to rate, review and subscribe so I can keep bringing you more content . . . and have a wonderful rest of your day.