Question

In 2019, Kevin converted $8,000 from his traditional IRA to a Roth IRA. There were no nondeductible contributions made to the traditional IRA. In 2022, when the value of the Roth IRA had grown to $8,350, Kevin, then age 62, withdrew the entire balance in a nonqualified distribution. What is the tax treatment of this distribution?

A. The distribution is not included in income and there is no penalty.
B. Only the $350 in earnings is included in income, but there is no penalty on the earnings distribution.
C. Only the $350 in earnings is included in income and there is a 10% penalty on the earnings distribution.
D. None of the distribution is included in income, but there is a 10% tax penalty on the entire distribution.

Answer 1

The correct answer is B. Only the $350 in earnings is included in income, but there is no penalty on the earnings distribution.

Since Kevin did not meet the five-year rule after converting to a Roth IRA and took a nonqualified distribution, only the $350 in earnings is taxed, and no penalty is assessed because he is over the age of 59½.

Step-by-step explanation:

The tax treatment of Kevin's nonqualified distribution from his Roth IRA depends on IRS rules regarding withdrawal of Roth IRA earnings before reaching the age of 59½ and before the account has been open for five tax years. Since Kevin converted his traditional IRA to a Roth IRA in 2019, and he took the distribution in 2022, the five-year rule for tax-free withdrawals of earnings does not apply as less than five years have passed since the conversion. Additionally, his age of 62 does exempt him from the early withdrawal penalty.

However, because the distribution is nonqualified (the five-year rule was not met), the $350 in earnings will be subject to income tax. There is no additional penalty since he is over the age of 59½. Therefore, the correct answer is B. Only the $350 in earnings is included in income, but there is no penalty on the earnings distribution.