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I have a Roth IRA that was opened and initially funded more than five years ago. Now that I'm earning too much money to make regular contributions, I'd like to further fund this account through a backdoor conversion. If I open a new traditional IRA, fund it with a non-deductible contribution, and convert it into my existing Roth IRA (and file Form 8606), will I be able to safely withdraw that contribution at a later date without being subject to the 10% penalty?

Backdoor Roth IRA conversions make sense but the five-year rule is confusing me. Thank you in advance.

Chris W. Rea
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mwp
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2 Answers2

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Assuming that the conversion was completely non-taxable (i.e. your Traditional IRA was 100% basis), then the converted money can be taken out at any time whatsoever (no 5 year or age stuff), without tax or penalty, similar to directly contributed money. For withdrawing conversions and rollovers within 5 years of the conversion or rollover, the penalty only applies to the part of the conversion or rollover that was taxable. Since in this case the conversion was completely non-taxable, there is no penalty on the withdrawal.

However, note that the ordering of the conversion money is not the same as for contribution money, and this may be significant in some cases. When you take money out of Roth IRA, it goes 1) contributions, 2) rollovers and conversions, and 3) earnings. However, money within (2) is then further divided by year, with rollovers and contributions for earlier years ordered before rollovers and contributions for later years, and then within each year, the taxable rollover and conversion money are ordered first, before the non-taxable money.

So what does that mean? Well, suppose you made a Roth IRA conversion that was taxable one year, and then the next year you make a contribution. If you withdraw a little bit, it comes from the contribution which is ordered first, which means no penalty. Now suppose in that second year you had a backdoor Roth IRA contribution instead of a regular contribution. If you withdraw, the first year's conversion is ordered first, and since it's within 5 years, there's a penalty. It's still true that withdrawing the backdoor Roth IRA has no penalty; but, you don't get to that money until you finish the other one. If you've never made a taxable conversion before, then this issue doesn't exist.

user102008
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For conversions you do not to be 59-1/2 to avoid penalty. The 5-yr rule thus creates an early withdrawal option if planned well in advance.

See the flow chart in http://www.irs.gov/publications/p590/ch02.html#en_US_2012_publink1000231030 For where I sourced the answer.

Note : I edited to correct my answer. User102008 called me out on my mistake, and rightly so. The dialog is in the comments, where he points out the mistake. Good job, new User.

JoeTaxpayer
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