Q3: Roth IRAs and the Five-Year Rules
I understand that to withdraw money from a Roth IRA without paying tax or a penalty on the earnings, the account owner must have had the money in the Roth IRA for at least five years and be age 59½ or older. My question relates to when the five-year clock starts if contributions are made over several years. Also, do the rules differ for Roth IRA conversions?
There are actually two five-year rules that apply to Roth IRAs. The first applies to Roth IRA contributions, including rollovers and conversions, and whether distributed earnings are tax-free to you. Under this rule, distributions of earnings after age 59½ aren’t taxed if at least five tax years have passed since the owner first contributed to a Roth IRA. For this first five-year rule, the five-year clock starts the first time that money is deposited into any Roth IRA that you own, through either a contribution or a conversion from a traditional IRA. The clock doesn’t start for later Roth contributions, conversions or for newly opened Roth IRA accounts.
The second five-year rule applies specifically to Roth IRA conversions, and whether the 10% early distribution penalty hits pre-age-59½ payouts. This rule is an anti-abuse rule to prevent people who are younger than 59½ from circumventing the early IRA withdrawal penalty by first doing a Roth conversion and soon thereafter taking the money out of the Roth IRA. That’s because the 10% early withdrawal penalty doesn’t hit Roth IRA conversions. This second five-year rule doesn’t apply to new contributions to Roth IRAs, but to conversions of pre-tax income from traditional IRAs to Roths. Under this rule, if someone who is younger than 59½ does a Roth conversion, and later takes a distribution within five years of the conversion and before turning 59½, then the amount of conversion principal that is withdrawn is hit with the 10% penalty. Once you turn 59½, you needn’t worry, even if you take a payout before your conversion meets the five-year period. Under this second five-year rule, each conversion has its own separate five-year period, which differs from the first five-year rule discussed above. For instance, if you do multiple Roth IRA conversions, there will be multiple five-year time periods, even if each conversion is done into the same Roth IRA account that you have owned for years.
You can read more about this in an article I’ve written about these two Roth IRA five-year rules, which includes examples and a set of FAQs.— Joy Taylor, Editor The Kiplinger Tax Letter
Q4: Publicly Traded Partnerships
I am thinking of investing in a publicly traded pipeline partnership. I understand that if I invest through my taxable account, I would get a K-1 form, which can be a headache. What about if I have my IRA buy the units? Any tax traps?
It is our understanding that most big IRA custodians will handle the preparation and filing of the 990-T, unless the IRA trust agreement between the IRA owner and the custodian provides otherwise. For self-directed IRAs, the burden of filing the 990-T would fall on the IRA owner. Any taxes owed on an IRA’s excess unrelated business taxable income are paid from available assets within that IRA.— Joy Taylor, Editor The Kiplinger Tax Letter
We have already received many questions from readers on topics such as qualified charitable distributions from traditional IRAs, the 10-year cleanout rule on inherited IRAs, and much more. We’ll answer some of these in a future Ask the Editor round-up. So keep those questions coming!
Subscribers of The Kiplinger Tax Letter can ask Joy questions about a tax topic. You’ll find full details of how to submit questions in The Kiplinger Tax Letter . ( Get a free issue of The Kiplinger Tax Letter or subscribe .)
Not all questions submitted will be published, and some may be condensed and/or combined with other similar questions and answers, as required editorially. The answers provided by our editors and experts, in this Q&A series, are for general informational purposes only. While we take reasonable precautions to ensure we provide accurate answers to your questions, this information does not and is not intended to, constitute independent financial, legal, or tax advice. You should not act, or refrain from acting, based on any information provided in this feature. You should consult with a financial or tax advisor regarding any questions you may have in relation to the matters discussed in this article.
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