Slott Report Mailbag: Is a Conversion From an IRA to a Roth IRA Subject to the 10% Penalty?

This week's Slott Report Mailbag looks at the 10% early distribution penalty, which is in affect before age 59 1/2 in many cases. We also answer a tricky question about Roth recharacterizations. 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.

1.

Ed,

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My daughter is 47 years old. She wants to convert funds from her traditional IRA to fund her Roth IRA each year. Even though she is not age 59 ½, can she move these funds without the 10% penalty since the funds are moving from one IRA to another?

Thanks!

Scott Wheeler

Answer:
A conversion from an IRA to a Roth IRA is taxable, but not subject to the 10% early distribution penalty.

2.

I have always considered my contributions to my Roth IRA as part of my emergency fund, knowing I could take the contributions (but not the earnings) before I reach age 59 ½ with no penalty. I also contribute to a traditional IRA. There was one year when my income unexpectedly jumped up above the level allowed for a tax-deductible IRA, but I didn’t realize I wasn't eligible until months after I made my contribution. Come April when I did my taxes I had this contribution re-characterized as a Roth IRA and paid taxes on it. My question is this: can the money I re-characterized be included as the portion of my Roth IRA, which can be taken out before 59 1/2 without penalty?

Answer:
Yes. Your recharacterized IRA contribution is treated as a Roth IRA contribution that can be withdrawn tax-and-penalty free at any time.

3.

I made three conversions in 2010. I know that I will be able to make qualified withdrawals on January 2, 2015. I also made a conversion on 1/3/2012. Must this conversion be governed by its own 5-year rule, meaning, qualified withdrawals will begin on 1/3/2017?

Thanks.

Answer:
Assuming you are now age 59 ½ or older, there is no separate 5-year clock for purposes of the 10% penalty on the 2012 conversion because that penalty doesn’t apply any longer. But, if you’re under age 59 ½, the 2012 has its own separate 5-year clock with respect to the 10% penalty. With respect to a qualified withdrawal of interest, there is only one 5-year clock that expires on 1-1-15. All of your future Roth IRA withdrawals will be qualified (tax-free) from then on.

- By Joe Cicchinelli and Jared Trexler

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