Help understanding the Roth 5 year rule

[dhoyt]

Hi all. I have a client who closed a Roth IRA in 2021. She received a 1099-R with the code J, Box 1 $10,538, Box 2a $3,138 (taxable amount). The taxpayer is 63 years old, but has only had this particular Roth IRA for 3 years, which is why the code J. However, she has had other Roth IRA's before, well before 2017, although those Roths have been totally distributed  in previous years and as of 12/31/21 she does not have any open Roth's. My understanding is that as long as she had any Roth prior to 2017, she should not be subject to the penalty or any tax on the earnings, even though this particualr Roth does not meet the 5 year requirement. Am I misunderstanding that rule, or should she not have to pay tax/penalty on the earnings?

Thanks in advance for your help.

[jeffmcpa2010]

During the 5 years before the distribution has she always had at least one ROTH open?

[rbynaker]

Not enough facts in evidence.  There are different 5-year rules that may apply.  Each conversion starts its own 5-year clock.  If you're lucky, @qbteachmt may come along with her list of awesome resources.  I found one that may help with a quick Google:

https://www.investopedia.com/ask/answers/05/waitingperiodroth.asp

You're not only a tax preparer, you're also a historian!  Sometimes an archaeologist if your clients records are anything like my clients . . .

[dhoyt]

Thanks for the response. I will confirm with her, but I do believe for at least the last 5 years she has always had at least one open Roth IRA. Last year she had a qualified roth  distribution (code Q), so she must have had that account for at least 5 years.

Thanks for the reference. If there was conversion from IRA to Roth, then that conversion would have its own 5 year clock. If there was not any conversion, then this wouldn't apply if I'm understanding correctly and based on the fact that she had an open IRA for the last 5 years, she shouldn't have to pay any penalty/tax on this distribution.

If that's the case, then I can't figure out how to make proseries rmake the whole Roth distribution nontaxable

[rbynaker · Accepted solution]

Wander around on the IRA Info Wks.  I don't remember where but somewhere there should be a checkbox for Roth IRA open for at least 5 years.  You can also enter the basis (but that shouldn't matter in this case).  If you're confident there's no tax / penalty on this, I would just put $0 in box 2a.  IMO if an IRA 1099-R doesn't check the "Taxable amount not determined" box, they're doing it wrong.  The IRS views all traditional IRAs as one big IRA and all Roth IRAs as one big Roth IRA.  So there's no way one institution can know with any certainty whether or not other accounts are open.

[dhoyt]

Yeah I've got the box checked on the IRA worksheet for "Roth Opened before 2017" and it still is taxing her on the gains. Even if I put "0" in the 2a taxable amount and check Taxable amount not determined, the system still reports it as taxable, I assume because of the J code.

Wait, I just found it. On the 1099R Wks is a box to check if you have "a code J or T and this is a qualified Roth IRA distribution." Checking that gets her out of the taxes. I will confirm all the details with her one more time (no conversions, had any roth opened since 2017) and then will get her out of the penalty with that info.

The fact that I couldn't get the system to acknowledge the qualfified nature made me question what I thought I knew about Roths. Thanks for the help in talking me through it to find the answer

[rbynaker]

Glad you found it.  ProSeries is very particular when it comes to IRAs.  You have to bounce around like a pinball between the 1099-R, IRA Contrib Wks, IRA Info Wks, etc.

[qbteachmt]

This is why it is recommended to open a Roth and park $500 in there, for future use to be a qualifying account. That satisfies the "has had Roth" for that specific 5 year rule.

"although those Roths have been totally distributed in previous years"

So, this was the only open Roth? Well, the rule is in regards to first contribution to Roth account. Not to that Roth account.

"My understanding is that as long as she had any Roth prior to 2017"

It uses tax years. To meet the 5 year rule, funds removed in 2021 means the first contribution needed to be for tax year 2016, made as late as the filing of that tax return in 2017. Not "prior" to 2017, but made for Tax Year 2016, even if made in 2017.

Other 5 year rules relate to Contribution/Distribution, and to Conversion. The sequence for taking is Contributions, Conversions (which have their own 5 year rule) and Earnings. Conversions are based on the calendar year of the conversion for the 5 count.

Remember that the Code is used by the issuer. They don't know about the rest of her life or what else is going on or what she did with the funds. The earnings might be taxable, but at 63, there should not be a penalty.

You didn't mention why she did this:

https://www.wealthenhancement.com/s/blog/understanding-the-5-year-rule-for-roth-ira-withdrawals-MCBT...

"There are certain situations in which the 5-year rule for Roth IRAs can be ignored. You may take tax-free distributions from your Roth IRA at any time, at any age, and from any source (contributions, conversions or earnings) for any one of the following reasons:

• Making a down payment on your first house (withdrawal amount capped at $10,000)
• Paying for higher education for yourself, your spouse, your children or your grandchildren (withdrawal amount capped at $10,000)
• Paying for health insurance premiums
• If you become unemployed
• Paying for medical expenses that exceed 10% of your adjusted gross income (AGI)"

[dhoyt]

"this was the only open Roth?"

Correct this was the only open Roth in 2021. All others had been closed in the last few years. So at end of 2021 all Roth IRAs are gone.

"To meet the 5 year rule, funds removed in 2021 means the first contribution needed to be for tax year 2016"

Right, she has had a roth for over 10 years so the exact date isnt an issue. Proseries just lists it as "Roth opened before 2017,"  meaning the 2016 Tax year or before.

Confirmed with her never  any conversions.

"Remember that the Code is used by the issuer. They don't know about the rest of her life or what else is going on or what she did with the funds. The earnings might be taxable, but at 63, there should not be a penalty."

Yeah the code was the problem. Finding the nifty "code J but treat as qualified Roth" button was the ticket to fixing that.  

Lastly, the reason was she retired. Actually she bacame diabled. So she might have had a way out of it that way too if we needed it.

Thanks for the reply. This is one of those things that only comes up (for me anyway) every few years for one of my clients. I always do my rsearch first, but it's great to have a place to discuss this stuff and get some help.

[qbteachmt]

To summarize then: The code was fine; there was no issue with that code. It's what the issuer knows.

"even though this particualr Roth does not meet the 5 year requirement"

They did not have this account for her for at least the 5 years, but the IRS treats all of your Roth accounts as if they are one. It is up to the tax payer to file with the follow up info that is pertinent. The 5 year rule didn't apply; she first contributed to a Roth years and years and years ago.

And the 2 other 5-year rules also don't apply.