5 year rule
L1: 5 year ruleA recent large return has ballooned my Roth to over $2M. I knew this was a possibility upon making the investment. So, before I did, I converted my traditional IRA to the current Roth IRA during calendar year 2010. With this reality and at age 46, I am interested in setting up the equal distributions allowed by 72t. It appears that the five year rule can be waived while setting up the equal annual payments as defined by 72t, is that true? If not, then under all circumstances, am I boxed in by the ‘five year rule’? Of course I could pay the penalty on money needed (wanted) …2011-01-20 17:54, By: On_Reserve, IP: [188.8.131.52]
L2: 5 year ruleIf you plan on using your Roth IRA for a 72t plan, note that there are 2 different 5 year holding periods for a Roth IRA:
1) For your Roth to be qualified as fully tax free. You must also be 59.5. Since your gains come out last, you would probably not be tapping your gains for several years, so this 5 year holding period is not a current issue for you.
2) 5 year holding period for conversions to avoid the 10% penalty. But SEPP payments are a penalty exception, so you could distribute your converted amounts tax and penalty free using the SEPP exception until you reach 59.5 and the age 59.5 exception thereafter.
3) But you do need to be aware of the income acceleration provisions with respect to 2010 conversions on which you choose to report in 2011 and 2012. If you withdraw any of these conversion dollars prior to 2012, the income you would have deferred is accelerated into the year of the distribution. This is not an additional tax, just an acceleration of the reporting date if you withdraw conversion dollars this year. If you had a Roth balance before your 2010 conversion, the amounts you contributed in prior years are distributed prior to your 2010 conversion, so you might avoid any accelerated income.
2011-01-20 20:31, By: Alan S., IP: [184.108.40.206]
L3: 5 year ruleI believe this answers my question … “SEPP payments are a penalty exception, so you could distribute your converted amounts tax and penalty free using the SEPP exception until you reach 59.5 and the age 59.5 exception thereafter.”
THE DETAILS: I converted $350K TIRA to a Roth IRA in March of 2010 I have the funds to cover the tax bill. I invested this money anticipating a very good return, but not the windfall that ballooned my Roth IRA to $2.34M. I only became aware of 72t over Christmas. Since then I’ve decided to set up the equal payments as detailed in 72t in order to create an annual cash flow now. I have not decided how much of the Roth to allocate to the SEPP acct.
Thanks for the response! Seems the main question is how I should pay the taxes. Perhaps I should wait until 2012 as recommended. The full Roth is now in a MM acct awaiting a trigger.
ONE MORE QUESTION: I am still unclear as to the interest rates within the SEPP. The limit appears to be about 2% as with most interest rates available on anything with the ‘penalty’ above 3%. The question is is that ‘locked in’ potentially for 13 years (in my case as a 46 y/o)? Or, is it adjustable as rates change over time? I see a few years ago interest rates were 4-6%.2011-01-20 21:50, By: On_Reserve, IP: [220.127.116.11]
L2: 5 year rulePlease provide figures, and more info.
Are you talking about the ROTH IRA 5-year rule, or the SEPP 72-T 5-year/59.5 rule ?
The ROTH IRA rule allows you to withdraw amounts up to your CONTRIBUTION tax-free, at any time, even before the 5 years. However, any “earnings”, such as Interest, Dividends, or CAPITAL GAINS must remain in the ROTH IRA account until 5 years after the conversion date. If there are multiple conversions, then each has its own 5-year term. BUT, if this was appreciation of 1 investment, then only that conversion date counts to start its 5-year period, even if there were other conversions.
If you converted this asset in 2010, which I assume from your posting, then you can only withdraw the original converted amount tax-free before 2015. Otherwise, all distributions in excess of that amount are taxable as ordinary income, plus a 10% penalty on the amount withdrawn.2011-01-20 20:31, By: dlzallestaxes, IP: [18.104.22.168]
L3: 5 year ruleI agree that it would be helpful to clarify the Roth tax situation with respect to distributions if we had more specifics:
1) What year did you first contribute to a Roth IRA, ie regular or conversion contribution?
2) What is your total of regular contributions and conversions over the years? Is is just the one time conversion of 350k?
3) Are you planning on reporting the 350k in your 2010 income OR 175k each in 2011 and 2012?
4) Ballpark estimate of the annual distribution you need, keeping in mind inflation over the next 13 years.
Note: You are not locked into the current low interest rate situation if you adopt a recalculation plan under which you adjust the account value, your age and the interest rate annually at the same time each year. While interest rates will probably rise, doing 13 calculations does increase the risk of making an error. The IRS does not see many recalculation plans, although they have authorized using them.
Note 2: You will never pay a 10% penalty if you have a valid SEPP because the SEPP itself constitutes an exception. You just file a 5329 every year and show exception 02 unless you custodian shows a 2 on your 1099R. The custodian will probably use Code J, which you would change to “02” on the 5329.
Note 3: If you had a gain of several hundred % on this conversion over a matter of months, be sure that you don’t run afoul of the IRS with respect to the original valuation of the asset at time of conversion or the whole scenario changes dramatically.
2011-01-20 22:32, By: Alan S., IP: [22.214.171.124]
L4: 5 year ruleBe careful re item # 2 above.
There are 2 different 5-year rules involving ROTH IRAs, and “‘ner the twain shall meet”.
ROTH IRA CONTRIBUTIONS use a 5-year period starting with the FIRST ROTH IRA CONTRIBUTION whenever it was, and even if only $ 100 20 years ago.
ROTH IRA CONVERSIONS have a separate 5-year period for EACH ROTH CONVERSION, and regardless if there was ever a ROTH CONVERSION.2011-01-20 23:06, By: dlzallestaxes, IP: [126.96.36.199]
L4: 5 year ruleAlan Thank you. This is the answer that I am looking for … “Note 2: You will never pay a 10% penalty if you have a valid SEPP because the SEPP itself constitutes an exception. You just file a 5329 every year and show exception 02 unless you custodian shows a 2 on your 1099R. The custodian will probably use Code J, which you would change to “02” on the 5329.”
MORE DETAIL: I separated from an employer after almost 22 years in Dec. 2008. The TIRA was a rollover from my 401K. During my career there, my contributions to the 401K amounted to $177K++ (+matching, +growth). I rolled it over in Jan/Feb 2009 and placed it into a MM until I could decide what to do with it. The first year that I contributed to the 401K was 1990 (or ’91?). It was a one-time conversion of the $350K to the Roth. I am now leaning toward splitting the taxes in ’11 and ’12. BTW, I have a second marriage finances and taxes separate, no kids.
I have played with the calculators here a little bit … I’d like to take about $75K per year. This will leave me with abetter than $1.75Mbalance at age 60 and give me some flexibility for time off (now) and then cushion me as I decide the next endeavor (within a year or so). Since the money is coming out tax free, I figure that I can then allocate any extra (discretionarysay 5 years from now) into some long-term investments. Frankly, I like the ultimate flexibility of this. I may accelerate my mortgage($397K balance 21 years left) as I am getting a greater appreciation for being debt free.
Iresearched your recalculation option, but it seems far too complicated and with too many alligators.2011-01-21 16:16, By: On_Reserve, IP: [188.8.131.52]
L5: 5 year ruleI agree that recalculation is potentially hazardous and best avoided in most cases. The last two months have posted nice interest rate increases which will generate more dollars for your SEPP per dollar of IRA balance.
If you had no prior Roth IRA, note that the income acceleration provisions for your conversion will change your taxable income for the conversion from 175k in 2011 and 2012. If you take out 75k this year, the conversion income will change to 250k in 2011 and 100 in 2012 under the acceleration provisions. This is handled on Form 8606 in 2011 although you must report the 2010 conversion on a 2010 8606 also.
Remember that you will need to start out with a high enough distribution to cover 13 years of inflation or you will run short before age 59.5. But if you take another job you can also reduce your distribution by making a one time switch to the RMD method, and then use RMD from there on.2011-01-21 17:18, By: Alan S., IP: [184.108.40.206]
L6: 5 year ruleThank you, Alan, for your expertise, opinion and guidance.2011-01-22 00:45, By: On_Reserve, IP: [220.127.116.11]