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Pro-Rata Rule, Dlsclaimers and IRA 5-Year Rule Highlight Mailbag

This week's Slott Report Mailbag answers questions on the pro-rata rule, the 5-year rules involving IRAs and using a disclaimer for inheriting IRA funds. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

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I have a client who has an inherited Roth IRA and an inherited IRA. Would these two inherited IRAs be included in the pro-rata rule if he were to fund a non-deductible IRA and immediately convert it to his Roth IRA (non-inherited)?

A Roth IRA is not counted in the pro-rata rule. An inherited IRA is separate from contributed IRAs, and a separate Form 8606 would have to be filed for that IRA. You would use your contributory IRAs, including SEP and SIMPLE IRAs, in applying the pro-rata rule. Think of it as who put the money into the IRA.



Reading your column in the January 2012 edition of Financial Planning raises some questions in my mind. In two of the questions, you seem to imply that the establishment of ANY Roth IRA starts the clock on the 5-year rule. Is that true? For example, a 40-year-old establishes a Roth IRA in January 2007. In March 2012, he establishes another Roth IRA, which contains funds converted from a Traditional IRA. Could he withdraw those converted funds and not pay a penalty tax?

Thanks for your input.

Joe B
Austin, TX

There are two 5-year rules, one for tax-free distributions and one for penalty-free distributions. The five-year rule for tax-free distributions starts when the first Roth IRA was established in January 2007. That Roth IRA can be used to satisfy any additional Roth IRAs they establish. Once five years pass and the other qualifications for a qualified distribution are met (age 59 ½, death, disability, first time home buyer), all distributions are tax-free. A non-qualified distribution of earnings in the Roth account will be subject to income tax and the 10% early distribution penalty, if applicable.

Converted funds in a Roth IRA have their own 5-year rule. If the account owner is under the age of 59 ½ and the converted amount has been held for less than five years, then the distribution is subject to the 10% early distribution penalty. Each conversion has its own five-year holding period.


My brother died on July 17, 2009, leaving a Roth and traditional IRA plus an individual (TOD) account. The beneficiary is my daughter (age 30) and my wife is the contingent beneficiary. We were told that my daughter can no longer disclaim the inheritance and that there is a 50% penalty on the withdrawals that are required by the IRS. What would be the best course of action at this point to not incur any further penalties and minimize the tax liabilities?

Phil Cappelluti

You are correct that your daughter can no longer disclaim the interest in the IRAs inherited from her uncle. In order to disclaim, it had to be done within nine months of the death of your brother.

Your daughter as primary beneficiary can inherit both IRAs by establishing two inherited IRAs. One would be the inherited Roth and the other an inherited traditional IRA. The regulations require that your daughter, when inheriting the Roth and traditional IRAs, must commence taking her RMDs (required minimum distributions) in the year after the death of your brother. That means her first RMD should have been taken in 2010 and another one in 2011 based on her single life expectancy from the Single Life Expectancy chart found in IRS Publication 590 and reduced by one each succeeding year.

No income tax would be due on the Roth IRA distributions.

Your daughter should establish the inherited IRAs immediately and take the 2010 and 2011 RMDs out and file Form 5329 with a note explaining the circumstances and that the missed RMDs were corrected as soon as it was discovered. There is a good chance that the IRS would forgive the 50% penalty for not taking the RMDs for 2010 and 2011. Filing Form 5329 will start the statute of limitations on the penalty. If you don't hear from the IRS in three years she will not have to pay a penalty.

-By Marvin Rotenberg and Jared Trexler


If converted amounts are distributed before they have been held for 5 years, AND the account owner is under age 59½ at the time of the distribution, the 10% early distribution penalty will be applied to the amount of the distribution. May I then assume that when the owner of a conversion account turns 59½ AND has otherwise met the five-year rule for tax-free distributions, all amounts (conversions and earnings) may be withdrawn tax and penalty free?

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Thursday's Slott Report Mailbag

Consumers: Send in Your Questions to [email protected]

Can I transfer money from my IRA to my husband's Roth IRA? I am 35, and he is 36.

Thank you!

Gail Clements

No. The only way your IRA funds can be transferred to your husband’s IRA is in a divorce or after your death. Even then, it would have to be transferred to a similar IRA, for example an IRA to IRA or a Roth IRA to another Roth IRA. In this case, you cannot transfer your IRA into your husband’s Roth IRA.