Retirement Savings and Benefits
Questions and comments about IRAs, 401k accounts, social security, and other forms of retirement savings and benefits.
Roth IRA Rules - Table Approach
Posted by: KAWill, October 11, 2010 06:27PM
The various tax and penalty cases for the Roth IRA were complicated enough that I decided to create a table showing the various cases.

The table below shows whether Withdrawals from a Roth IRA would be subject to Tax or Penalty or both. The table addresses the general case and not all the exception cases shown on Page 66 of IRS Publication 590.

This is a first cut at the table. Please let me know if you see anything that might be incorrect.

Note that the Five Year Rule for Conversions is determined individually for each separate Roth Conversion. This will determine if there is a Penalty for withdrawing the amount converted under Age 59.5.

Roth IRA Withdrawals first come out of Contributions followed by Conversions and then Earnings.

I have not looked at the IRS Tax Forms yet but assume that they separate Contributions, Conversions, and Earnings as required.

UNDER AGE 59.5
FIVE YEAR RULE NOT MET

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-Yes
Earnings: Tax-Yes Penalty-Yes

UNDER AGE 59.5
FIVE YEAR RULE MET

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No
Earnings: Tax-Yes Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No
Earnings: Tax-Yes Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No
Earnings: Tax-No Penalty-No

There is one interesting observation if the table is correct. Anyone with a Traditional IRA cannot generally make penalty free withdrawals until age 59.5. However, it appears that any amount converted to a Roth IRA could be withdrawn without penalty if held for at least five years in the converted Roth IRA regardless of age. Earnings would not be included.

Kent

Re: Roth IRA Rules - Table Approach
Posted by: Alan S., October 11, 2010 10:12PM
Kent,
All 12 of your scenarios is correct discounting the other non age related penalty exceptions. However, in the interest of not breeding confusion over the two different 5 year holding periods, I would refer to the conversion holding period as "5 year conversion holding period" rather than "5 year rule" The 5 year rule is an RMD option and not technically related to taxes on distributions.

Also, the last scenario shows a qualified distribution and the ordering rules no longer apply to them as they do to non qualified distributions. As such there is no need to break down the Roth into contributions and earnings since there is no 8606 required to report that breakdown. But if you want to just track what happens to these contributions upon attaining qualification, you could leave it as is, perhaps enter (Qualified) after the "First Roth IRA" in the heading.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill, October 12, 2010 04:01AM
Alan,

Thanks very much for reviewing the table and providing your feedback.

I had forgotten about the 5 Year Rule and will replace the term as you suggested with 5 Year Conversion Holding Period.

Excellent suggestion also on the last section covering Qualified Distributions.

I hadn't studied Form 8606 until just now and that explains a lot. I was familiar with the form in regards to non-deductible Traditional IRAs, and now see that Part III handles the non-qualified Roth IRA distributions. It undoubtedly keeps a running total on the two types of basis from year to year.

The Roth IRA suddenly seems simpler than I thought previously. For a while all the rules seemed overwhelming, but once you understand all aspects things begin to make sense.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill, October 12, 2010 09:50PM
Attached below is the update to the table.

I just noticed that the instructions for Form 8606 and Form 5329 include cases where they require the taxpayer to get information from every Roth IRA Account back to 1998. Roth IRAs first became available in 1998.

The instructions show the long list of dates from 1998 to the present and specific information that may be needed for each year.

Is that list just going to continue to grow every year and get longer and longer? It would be nice if there was a simpler way to handle those cases.


Roth IRA Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-Yes
Earnings: Tax-Yes Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No
Earnings: Tax-Yes Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No
Earnings: Tax-Yes Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Withdrawals Are Qualified

No Taxes
No Penalties

Re: Roth IRA Rules - Table Approach
Posted by: Alan S., October 12, 2010 11:32PM
Looks good.

All that complexity regarding Roth distributions in the 8606 Inst is to enable proper reporting of non qualified Roth distributions. While the purpose of a Roth IRA is to save for retirement when all distributions will be qualified, for those who take earlier distributions, proper reporting requires detailed documentation of all prior Roth contributions and distributions in order to determine what the current distribution is coming from under the ordering rules. Very few people have their documentation in order and are going to have a problem completing the 8606 if they take non qualified distributions. I recommend a tally sheet to show the amounts of regular contributions each year, conversions each year and distributions each year that will reduce those prior contribution balances. If current, the reporting of another distribution will be easy, otherwise a research project.

The 5329 tables are for the purposes of determining how much of the distributed amount is subject to the 10% early distribution tax, and is similar to the above, but for purposes of the penalty.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill, October 13, 2010 06:10PM
Alan,

Thanks for the explanation. It does appear that the long list of dates starting with 1998 will continue to grow in the Instructions for both Forms.

It could go on for quite a while. Someone 15 years old or even younger could have opened a Roth IRA in 1998, so it could be 45 years or more until they are past the penalty period ending at Age 59.5.

Maybe at some point the forms will cover a rolling period and start incrementing the starting date which is currently 1998.

Regards, Kent

Re: Roth IRA Rules - Table Approach
Posted by: Alan S., October 14, 2010 12:50AM
I agree. Eventually the listing of individual years will get very long and unwieldy. At that point the IRS will likely substitute a narrative statement explaining what the Roth owner must do to determine the remaining basis in regular and conversion contributions.

Actually, I think they out to consider doing that now as 12 years is long enough to maintain this listing. Of course, it is easier for the IRS just to update the list than to revise the instructions in a manner that is clear enough for people to understand.

Re: Roth IRA Rules - Table Approach
Posted by: kaneohe, October 14, 2010 06:44AM
Kent,

Very nice summary.......I've bookmarked for future use.

The ordering rules for withdrawals suggest 2 categories for conversions..one for which you paid tax at conversion and another
for which you paid no tax. How does that affect the table and
would it be useful or not to include that effect, if any.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill, October 14, 2010 06:25PM
Re: "Very nice summary.......I've bookmarked for future use. "

Thanks for the compliment. One can also cut and paste the table into a text document of various types.

If I understand your question, Conversions are from a Traditional IRA, SEP IRA, SIMPLE IRA, or Qualified Retirement Rollover to a Roth IRA and I believe all cases would involve paying tax as part of the conversion. Contributions are simply any regular Roth IRA contributions that hopefully are within the limits for that individual.

For those who make non-qualified withdrawals, the Table is only the starting point. One then needs to deal with filling out Forms 8606 and 5329. That may involve some significant work. The ordering of withdrawals is taken care of at that time, and cost basis for both contributions and conversions is determined.

Re: Roth IRA Rules - Table Approach
Posted by: kaneohe, October 14, 2010 07:25PM
I may have used the word "bookmark" incorrectly since what I actually did was to cut and paste to e-mail so that somebody else worries about archiving. I've had too many old urls become obsolete and useless.

I guess what I was asking was if you had only a non-deductible IRA and converted that to a Roth....then subsequently (before age 59.5 and before 5 yr conversion window was up) withdrew enough to get into this conversion, would a penalty be assessed? I guess that would make sense if it still had that TIRA attribute before the 5 yr clock ended?

Re: Roth IRA Rules - Table Approach
Posted by: Alan S., October 14, 2010 08:40PM
Good point. If you distribute some of a fully non taxable distribution prior to the 5 year holding period, there is NO penalty since the early withdrawal penalty only applies to amounts that were taxable.

To that end, Kent's table could be revised to incorporate that feature of the ordering rules as follows:
1) Expand the list to 4 newly labeled categories
Regular Contributions
Taxable Amount of Conversions
Tax free Amount of Conversions
Earnings

2) The tax free Amount of Conversions would read the same as the taxable amounts except for the under 59.5 and under 5 year holding not met category where the Penalty would show as "No".

Don't know how much he wants to expand these tables for special situations, but this is the only change needed to incorporate all of the ordering rules. There could also be a footnote that indicates that the table is not applicable to timely distributions of excess contributions or return of regular contributions.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill, October 15, 2010 03:57AM
Thanks Kaneohe for bringing up the Nontaxable issue.

I think Alan's suggestion is an improvement to the Table since the ordering rules do include both the Taxable and Nontaxable portions.

Here is an update to the Table including Alan's suggested note at the end. Thanks once again for the help.

Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-Yes (Taxable Portion)
Conversions: Tax-No Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No (Taxable Portion)
Conversions: Tax-No Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No (Taxable Portion)
Conversions: Tax-No Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

No Taxes
No Penalties

Note: The table is not applicable to timely distributions of excess contributions or return of regular contributions.

Re: Roth IRA Rules - Table Approach
Posted by: Alan S., October 15, 2010 04:26AM
Looks good.

Re: Roth IRA Rules - Table Approach
Posted by: kaneohe, October 15, 2010 05:18AM
I'm starting to like this process: Kent does all the hard work building the tables; Alan critiques; I get a lifetime reference document that I now have to update w/ cut and paste.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill, October 15, 2010 06:25PM
This has been an enjoyable and productive thread, and I find that I understand and remember things better when I create documents myself and also dig into the IRS Forms and Instructions. There is a lot more to Form 8606 than I realized and I had not previously looked at Form 5329.

I create the Table typically in Notepad and insert the right number of spaces to line up the various entries in the columns.

This forum seems to disregard multiple spaces or any attempt at formatting, and reduces multiple spaces to a single space. As a result, the columns did not come out straight. I did not attempt to use Tabs but doubt that would have helped.


Re: Roth IRA Rules - Table Approach
Posted by: kaneohe, October 16, 2010 02:03AM
Kent,

One thing that might helped was some punctuation (, or ;)
as in: Tax-No ; Penalty-No
I was reading it as: Tax-NoPenalty-No which confused me greatly
but I finally broke your code.

Re: Roth IRA Rules - Table Approach
Posted by: Alan S., October 16, 2010 02:19AM
The challenge of doing a such a chart is substantial, and in fact I am not aware of any firm attempting to capsulize this in chart form, including firms that have dozens of charts. I think the amount of footnotes required has scared them off.

Pub 590 has a Worksheet on p 67 that generates the taxable amount of a Roth distribution, but these worksheets are very difficult to conceptually understand what with all the subtracting of various lines. A chart provides an idea of what should be taxable and can be a useful check on whether an error was made in the worksheet or not.

Tax software will of course perform the calculations accurately, but you still need to enter the right info into the program.

Re: Roth IRA Rules - Table Approach
Posted by: Spike, April 6, 2012 11:41AM
Nice work on the chart however I am wondering if I understand it correctly. I have a brokerage Roth IRA that I have had for years. It is very small since it never recovered from the early 2000 years downturn. It is invested in one stock. I am now considering opening another Roth IRA based on your chart. I fall in the following category:

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Withdrawals Are Qualified

No Taxes
No Penalties


If I put 20K in a Roth IRA now are you saying that after 5 years both the principal and earnings are tax exempt when I withdraw?

Spike

Re: Roth IRA Rules - Table Approach
Posted by: kaneohe, April 6, 2012 01:08PM
The way I read it.....since you opened the 1st Roth over 5 yrs ago (early 2000s), and are over age 59.5, you can withdraw from this or any other Roth you have or will have anytime w/o tax/penalty. I agree w/ you that
KAWill and Alan S. did a great job on the table. I have made a lot of money (or would have had the others paid off :) ) on Roth withdrawal questions
which are quite confusing/misleading if you try to read IRS pubs piecemeal.

note that there are several versions of the table. You should be reading the last version since there are several changes in content and wording that improve things from version 1 to version N.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill, April 6, 2012 08:43PM
Re: "If I put 20K in a Roth IRA now are you saying that after 5 years both the principal and earnings are tax exempt when I withdraw?"

Note also that the Contributions to a Roth IRA are never taxed when withdrawn since that represents after-tax money. No tax deduction is allowed when contributing to a Roth IRA.




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