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Clarifying the Five-Year Rule For Roth IRAs
Friday, August 31, 2012
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Ask Ed Slott: Your IRA Expert answers readers' questions about the five-year rule for Roth IRAs.

Ed Slott was named "The Best" source for IRA advice by The Wall Street Journal and called "America's IRA Expert" by Mutual Funds Magazine. He is a widely recognized professional speaker and educator specializing in retirement distribution planning, teaching both financial advisors and consumers how to best take advantage of our complicated tax code.

-- Have something you want to ask Ed? Send your questions to mailbag@irahelp.com

This week, IRA expert Ed Slott answers readers' questions about the five-year rule for Roth IRAs.

Question 1:

Ive read your books and now your site. My father-in-law has $200,000 in his traditional IRA all stocks) and his wife has about $40,000 in hers (CD). They are elderly and take required minimum distributions (RMDs). Last year I found out he cashed in an additional $20k of her traditional IRA because he was fed up with the bank it was in! If I'd only known he was going to take extra distribution I would have told him to roll it into Roth IRA.

Anyway, he has plenty of money outside the IRA money and does not need it to live on.  We have recently made him update his beneficiaries. He has two boys so one gets 50%.  My husband doesn't want his share and wants it to pass it on to our kids directly without having to disavow it so our two kids are each listed as 25% per stripes.

Im trying to get my father-in-law to convert a chunk of his IRA to a Roth this year and another chunk early next year. He is listening so we have decisions to be made as to which stocks, etc.

Im still confused on the five-year rule around distributions. He is 81 and if his Roth is less than five years old at the time of his death, do the beneficiaries (ages, 22, 25, 50) have to take RMDs the next year or are they not allowed to take yet without penalty? 

In one place in the book, it seems like they have to start RMDs and in another place it seems to say there is penalty if take before five years is up. Can you please clarify this?  The answer may play a part in determining how much he converts to a Roth.  My kids could wait the five years if necessary. However, my brother-in-law might rather blow it early and lose out on the stretch beauty here.

Thanks for clarifying.



To keep the answer to your question "simple," I am ignoring several facets of the Roth five-year rules and am concentrating on only those provisions that apply in this case. All Roth accounts are treated as one account of the Roth owner or the individual Roth beneficiary.  

Roth distributions are deemed to come from annual contributions first (which you don't have), then from conversions, then from earnings.  Distributions of your father-in-law's (age 81) converted amounts will be income tax free as the tax was paid when the funds were converted.  Once all the converted funds are distributed, then earnings will be distributed.  If the earnings are distributed before five years are up, then they will be taxable.

The distribution will not be subject to any penalties - your father-in-law is over the age for penalties to be assessed and there is never a penalty on a distribution to a beneficiary.  The five-year period starts on January 1 of the first year your father-in-law establishes a Roth IRA.  For example, he does a Roth conversion in October, 2012.  The 5-year period starts on January 1, 2012 and any distribution of earnings taken by either the account owner or the beneficiary after January 1, 2017 will be a "qualified" distribution and will not be subject to income tax.  

Roth IRAs inherited by non-spouse beneficiaries do have required distributions beginning in the year after the death of the account owner.  The beneficiaries do not have the option of waiting until the 5-year period is met.  If the beneficiaries take required distributions only, there should be no income tax owed as they will be coming out of the converted amounts until the total amount converted is distributed.

Question 2:

Since I must begin taking my RMDs and I do not need the money, what is the best way that I can leave this money tax free to my children?


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