How Does the 5-Year Holding Period Work for Distributions From In-Plan Roth Conversions?

Q: We recently added the in-plan Roth conversion feature to our 403(b) plan. Can you please clarify how the five-year holding period for subsequent distributions is calculated on in-plan conversion assets? Does the five-year clock start after the first conversion and apply to all subsequent conversions or does each conversion transaction carry its own five-year requirement?

Kimberly Boberg, Kelly Geloneck, Emily Gerard and David Levine, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

A: The answer to this question is a bit tricky since there are technically two different types of holding periods; one for the purpose of a 10% penalty (known as the Code Section 72(t)

“recapture” rule) and another for determining when earnings can be distributed tax-free or the so-called “qualified distribution” holding period of Code Section 402A.For the 10% penalty, the five-taxable-year period begins January 1 of the year of EACH in-plan conversion and ends on December 31 of the fifth year. Thus, each Roth conversion has its own five-year holding period. However, the member is exempt from the 10% penalty if (1) an exception applies (e.g., age 59 ½, termination of employment after age 55, etc.) or (2) if the distribution is allocable to a non-taxable portion of the in-plan Roth rollover. For purposes of tax-free distribution of earnings, the five-year holding period begins January 1 of the year the FIRST conversion (or the year of the first Roth contribution to the Plan, if earlier) and is not affected by any future conversions, meaning that the five-year holding period ends on December 31 of the fifth year after the first conversion, regardless of any subsequent conversions. However, the employee must attain age 59 ½, die, or be disabled in addition to satisfying the five-year holding period.

NOTE: This feature is to provide general information only, does not constitute legal advice and cannot be used or substituted for legal or tax advice.

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