IRA Rules

Question: Question regarding a Roth IRA conversion?

My Dad converted a traditional IRA to a Roth IRA at the age of 57 (I believe the government allowed people do this recently). Does he have to wait five years before he can withdraw funds tax free, or will the 59 1/2 age rule take precedence in this case?

Much appreciated.

Answer: “If you convert a traditional IRA into a Roth IRA, then you must wait at least five years from the first day of the tax year in which you made the conversion before you can take a qualified distribution.”

http://www.money-zine.com/Financial-Planning/Retirement/Roth-IRA-5-Year-Rule/

1. I don’t know what was the motivation to convert a Traditional IRA to a Roth IRA at 57 years of age unless:

(A) There is NOT a large amount of money that is being converted;

(B) His tax bracket is very low, and the conversion will not jump him to higher tax brackets say 25% or higher.

(C) He plans to work for another 15-20 years; or has no need to tap this money for that period of time, and believes he has the income to make up for the taxes paid on the conversion and will pay those taxes from another NON retirement account.

One can convert a Traditional IRS or a ROTH anytime.

The problem is if you are under 59 1/2, there is a 10% tax penalty of the ENTIRE amount converted, UNLESS:

1. He retires early and has taken fixed payments based on actuary tables (he would need help with this in advance and declare this option PRIOR to taking the ROTH conversion in order to avoid ONLY the 10% penalty); or

2. The amount of IRA money was deposited in the “Traditional IRA” as “after tax contributions” and if that can be proven as such, thus those principle amounts ONLY are not subject to ordinary income tax on converting to a Roth IRA, but ARE subject to the 10% early withdrawal penalty because the funds came from a Traditional IRA and withdrawn before 59 1/2.

Next, except for where exempted (above), the ENTIRE amount of assets (cash, stocks, funds, etc) converted from the Traditional IRA to the Roth IRA will be subject to ordinary income tax in the year the conversion was executed.

Again, I would not pay all these taxes and penalties with retirement money. This should be paid with other funds that are not part of retirement planning.

I don’t know your dad’s personal situation, but based on the statements here, I would not have suggested a conversion unless I knew a lot more and compelling reason to do this.

Disclaimer: I am not a tax or legal advisor and I would highly seek a tax and or legal advisor BEFORE engaging in any tax planning, legal issues, and seek a qualified tax advisor especially regarding ROTH conversions.

Further Reading:
Roth IRAs: To Convert or Not

http://www.smartmoney.com/Personal-Finance/Retirement/Roth-IRAs-To-Convert-or-Not-7965/

http://www.nytimes.com/2010/03/04/business/retirementspecial/04ROTH.html

For Shift to Roth I.R.A., Know the Pitfalls to Avoid

Roth IRA Rules of Thumb

http://www.fairmark.com/rothira/thumb.htm

How to Time Your Roth IRA Conversion

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