By Andy Ives, CFP®, AIF®
IRA Analyst
QUESTION:
My wife has two after-tax traditional IRAs at two separate institutions. We are hoping to consolidate them, then convert to a Roth in the next 18 months. She is already retired. She also has an inherited IRA (from her father). Does the calculation for taxation on the conversion to Roth need to include the assets in the inherited IRA? Do assets in my IRA have any impact on the calculation?
ANSWER:
The calculation you are speaking of is the pro-rata rule. When an IRA containing after-tax (non-deductible) dollars is totally or partially converted, we must determine the ratio of how much of the conversion is taxable and how much is tax-free. (You cannot target just the after-tax dollars and only convert those.) There is no problem with your wife consolidating her “after-tax IRAs.” Subsequently, when she does a conversion, her inherited IRA is disregarded for the pro-rata calculation as are any IRAs you (as her spouse) have.
QUESTION:
There seems to be some confusion about a 5-year rule as it applies to Roth IRA conversions. I am under the strong impression that if you are over age 59½ and you convert $100,000 and pay the taxes due on that conversion, then that money is now available for use or withdrawal from the Roth IRA with no taxes. For example, if I am age 65 and find that I need $25,000 next summer after doing a $100,000 conversion less than 5 years ago, do I have to pay taxes on this withdrawal? I already paid the taxes on the converted amount, I don’t think so, but I can’t find anything on the IRS website, or even any articles online, that prove I am correct.
Robert
ANSWER:
Robert,
You are correct. In the scenario you outlined, there would be no taxes due on that $25,000 withdrawal from your Roth IRA. Roth IRA distributions follow strict ordering rules. Contributions come out first, then converted dollars, then earnings. Assuming there were no contributions in your Roth IRA, if you did a $100,000 Roth conversion and then took a $25,000 distribution, that distribution would be comprised entirely of converted dollars. Converted dollars are always available TAX-free, regardless of age, because as you said, you already paid the taxes due on those dollars when you did the conversion. (And, since you are over age 59½, the converted amounts come out PENALTY-free as well.)
https://irahelp.com/slottreport/the-pro-rata-rule-and-roth-conversions-todays-slott-report-mailbag/