Ask the Expert: IRA conversions and penalties

Converting money from a traditional IRA to a

Converting money from a traditional IRA to a Roth IRA doesn't give you a free pass on the 10 percent early-withdrawal penalty. (Credit: iStock)

Lynn Brenner

Lynn Brenner Lynn Brenner

Brenner answers questions about all aspects of family finance.

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Your Dec. 8 column incorrectly implies that an early-withdrawal penalty applies on a conversion of a traditional IRA to a Roth IRA. IRS rules specifically state that the 10-percent penalty on early distributions doesn't apply to money converted to a Roth IRA.

 

You're right that money converted to a Roth IRA isn't subject to the 10 percent early-withdrawal penalty at the time of the conversion. But the penalty doesn't disappear.

Let's say you're 50 years old. You want to take $10,000 from your traditional IRA without paying the 10 percent penalty on distributions taken before you turn 591/2. So you move the $10,000 into a Roth IRA. Although you pay taxes on it, there's no early withdrawal penalty on the conversion. Soon afterward, you take your $10,000 out of the Roth IRA. Your withdrawal is free of income taxes because you paid them when you transferred the money to the Roth. Have you also escaped the 10 percent early withdrawal penalty? Nope.

The rule book says if you take a distribution from money converted from a traditional IRA to a Roth IRA within five years after the conversion or before you're 591/2 (whichever comes first), the early-withdrawal penalty applies to that distribution. So if you did the Roth conversion at age 50, the penalty applies for the next five years.

Ideally, of course, this won't matter because you won't need to tap the Roth IRA for 15 to 20 years. Indeed, it may take that long before this account's investment earnings surpass the tax you paid on the conversion. But you should be aware that the penalty is still in force on early distributions.

The bottom line Converting money from a traditional IRA to a Roth IRA doesn't give you a free pass on the 10 percent early-withdrawal penalty.

Websites with more information bit.ly/YWI7UW and 1.usa.gov/VAwFGH

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