“I converted $18,000 in a traditional IRA to a Roth IRA in 1998. I also made $20,000 in contributions over the years 1998-2010. Last year I took a distribution of $38,000. I am under age 59 1/2.
Do I have any taxes or penalty on this withdraw?”
No, as you describe the situation. Regular contributions come out first, followed by Roth conversions, and finally profits. The rules for calculating any taxable amounts from a Roth IRA distribution are described in IRS Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs). The explanation begins on page 30. You can access this information by clicking on the link below:
As you will see, you will need to attach some tax forms to your return to claim this exemption. If you’re not sure how to complete the forms, the assistance of a tax professional may be advisable.
There are plenty of articles on the web which explain the rules. Many tax preparers get very confused because there are two different 5 year clocks which apply to Roth IRAs. One is the qualified distribution clock, which requires you to have a Roth established somewhere for your benefit at least 5 years prior to the distribution for it to be qualified, and additionally you have to be 1) over 59 ½, or 2) totally and permanently disabled; or 3) dead and the distribution is to your heirs; or 4) you are taking no more than $10,000 for a first time home purchase. A qualified distribution is one on which there is no penalty and no taxes. Once you are into qualified distributions, the 5 year conversion clock becomes wholly irrelevant.
The second 5 year clock, which applies in your case, is the Roth conversion clock, and it is used to determine whether or not you owe a 10% premature distribution penalty if you are under 59 1/2 and don’t meet any of the other exceptions. This conversion clock has nothing whatsoever to do with taxation of the distribution, it only has to do with the 10% premature distribution penalty.
As you already know, Roth distributions come out of the account in a certain order, which is:
1) Regular contributions;
2) Taxable Roth conversion contributions;
3) Non-taxable Roth conversion contributions; and
4) Profits on all contributions.
In the first three categories, the taxes have already been paid on the money, so there is no tax due and it is only a question of the penalty. If you get into the profits and it is not a qualified distribution, then taxes are owed on that portion. So how are the penalties figured? Your regular Roth contributions are never taxed or penalized upon withdrawal, even if you are under 59 ½ and meet no other exception. Once you go past your regular Roth contributions you have to figure out whether a penalty applies, again assuming you do not meet one of the other exceptions to the penalty.
With taxable Roth conversion contributions, which appears to be what you are describing in your email, the penalty will apply if you withdraw the money within 5 tax years of the conversion. After this, no penalty applies. In your case, if you converted in 1998, no penalty should apply because it has been in your Roth IRA for more than 5 tax years, even though you are under age 59 ½. Each Roth conversion has its own 5 year clock, and the conversion withdrawals are taken on a first in, first out basis.
The purpose of the 5 year conversion clock is to prevent abuse of the rules. For example, I am under 59 ½ (although some days I don’t feel that way!). If I do a Roth conversion, of course I pay taxes on the conversion but no penalty. If the 5 year conversion clock were not in place, I could simply withdraw the money from the Roth IRA and avoid the 10% premature distribution penalty entirely. The rule was put in place to prevent this from occurring. It forces you to recapture the 10% penalty you would pay if the money was still in the traditional IRA.
Hopefully that helps clarify where this is coming from. I find often that understanding the background of a rule makes what is otherwise confusing a little more clear. I do think that if your tax preparer follows through on the calculations in Publication 590-B that should resolve any doubts.