Ask Terry Questions Roth IRA witdrawals penalized? Wrong advice from CPA?

Roth IRA witdrawals penalized? Wrong advice from CPA?

By Terry Savage on May 28, 2014 | Financial Planning / Retirement

Dear Terry,
You may not remember me, but several years back I had the privilege of meeting you and having a rewarding discussion about Chicago politics and the financial markets. I’ve always been impressed with you straight talk and sound advice. It was a real pleasure, and I’m glad to see you are still helping others, but not surprised.

You keep telling people that there is no penalty for withdrawing funds from a Roth IRA, however I know differently, at least in my specific situation. I had invested in my company’s 401K, accumulating maximum amounts allowed for several years, until the company ended up selling off most of it’s assets and closing it’s doors. I had the opportunity to roll-over the amount saved into a Roth IRA and apply a large tax credit against the subsequent tax liability for removing it from the 401K early. It seemed be a small net gain, and afterwards I was able to take about $20K out to help fund a startup now that I was unemployed. This was in early 2012, and my CPA assured me that I could withdraw the contributed funds without penalty, just as you state. However, right at the end of 2012, there was apparently a tax ruling or law enacted that allows the IRS to assess a penalty for conversions like mine. To top it off, they made it retroactive to the first of the year! I’m being told that this penalty will continue to be applied to any amount withdrawn within five years of the conversion OR until you become 59 1/2 years old, whichever is the least.

It really seems unfair to have a law like that apply retroactively. It’s like adding a stop sign to an intersection after months of not having one and then fining everyone who didn’t stop that past year. I’d really like to know if you have heard of it, and if so, who actually created it.


Terry Says:  Well, there is a huge misconnection somewhere!  I forwarded your emailo to Ed Slott — the IRA guru.  He trains the advisors, and has written allthe best books on the subject.  Check out his website:  Here, I have cut and pasted his response to you.  Read carefully!

This is nonsense. There is no such “new” law.
That 5-year rule is the old law from 1998 when Roth IRAs began.
The CPA was right that contributed funds can be withdrawn tax and penalty free at any time – but these are NOT contributed funds. They are converted funds. That’s a BIG difference. The conversion from the 401(k) to his Roth IRA is not a “contribution” , it’s a conversion. The 5-year rule for the 10% (pre-59 1/2) penalty applies separately to each conversion. If any of the converted funds are withdrawn, the 10% penalty applies (until you reach age 59 1/2). There is no tax since the tax was paid when the funds were converted. He cannot withdraw the converted funds penalty free until 5 years or until he reaches age 59 1/2.
There is no “retroactive” “new law”.
The CPA should have told him that if he is under age 59 1/2 and withdraws converted funds within 5 years of the conversion, then he will owe a 10% penalty on those withdrawals. There is a big difference between Roth conversions and Roth contributions.

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