Q: I do not know how to handle withdrawals from a Roth IRA after performing multiple partial conversions. I know that every conversion has its own “five-year rule”, but I don't see a clear way to know how earnings are linked to each conversion. I couldn't find any revenue-handling information when multiple Roth conversions were done in the same Roth IRA. Can you bring me light into the dark?
ON.: Chris, it's not super easy, but easier than you fear. You do not have to link earnings to any of the transactions in your Roth IRA. This is billed on Form 8606. Instructions for Form 8606 will guide you through the process.
When you withdraw money from a Roth IRA, a number of ordering rules apply.
1. The first amounts are considered to come from your regular contributions. Since the contributions are paid after taxes, these withdrawals are tax-free.
Second Once you have distributed the equivalent of the total amount of your contributions, the next dollars distributed will be treated as converted amounts more than five years ago. You would have paid the tax at the time of the conversion. Since these converted amounts are older than five years, the five-year rule for conversions is fulfilled and no taxes or fees are due.
Third Next is the amounts converted less than five years ago. They would have paid the tax at the time of the conversion, but not the 10% penalty that would normally apply to amounts from an IRA before the age of 59. So if you take out more than the posts in # 1 and the older conversions in # 2 and are still under 59½, you will pay the 10% when you get these converted funds.
4th By default, the last thing that comes out after taking all previous posts and conversions is earnings. A second five-year rule plays a role here. For income to be tax-free, you must be at least five years old since you opened your first Roth IRA, even if this account is not yet open, and you must be at least 59½ years old. So if you are less than 59½ more than the amount specified in rules 1 to 3 above because the income in the Roth has never been taxed, you are taxable. You will also have to pay a 10% penalty if there is no tax exemption. If you are over 59½ years old, but less than five years have passed since you opened your first Roth, the income is taxable, but there is no penalty.
Let's say you deposited $ 10,000 over the years, converted $ 20,000 six years ago, another $ 30,000 two years ago, and the account is worth $ 70,000. The first $ 10,000 you earn is tax-free (# 1 above), as is the next $ 20,000 (# 2). The next $ 30,000 (# 3) removed will be tax free if you are over 59½ years old. If you are under 59½ years of age, you will be required to pay a penalty of $ 3,000 (10% of $ 30,000). The last $ 10,000 is revenue and is taxed based on Article 4 above.
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Dan Moisand's comments are for informational purposes only and do not replace personal advice. Ask your advisor what is best for you. Some questions will be dealt with for brevity,