By Sarah Brenner, JD
Are you one of the growing number of savers who has a Roth IRA? If so, there will come a time when you will want to take funds from your account. Here are 5 things that every owner should know before taking a Roth IRA distribution.
1. Your Roth IRAs are treated as one account. Things can get a little tricky if you have more than one Roth IRA. When determining the taxation of a Roth IRA distribution, all of your Roth IRAs are aggregated. What does “aggregated” mean? Well, simply put, this means of your Roth IRAs are considered one account for tax purposes.
Your IRA custodian will report the distribution on Form 1099-R to you and to the IRS. You will be responsible for determining the taxation of your distribution. You will use Form 8606 to report the Roth IRA distribution on your federal tax return.
2. Contributions are always tax and penalty free. Tax-year contributed amounts are distributed first. These amounts are not taxable or subject to the early distribution penalty, even if you take them out before five years or before age 59½. In other words, you always have access to your contributions tax and penalty free.
Maybe you contributed to your Roth IRA in 2015 and you are now 32 years old and need that money. You will not be taxed or subject to a penalty when those funds are distributed. It doesn’t matter that you are not yet age 59 ½ and it doesn’t matter how you use your money.
3. Converted amounts may be subject to penalty but never tax. Converted amounts are distributed next on a first in, first out basis. If you converted both pre- and after-tax amounts, the pre-tax amounts are distributed first. Distributions of converted amounts are not taxable. Remember you already paid taxes on those funds when you did the conversion.
Pre-tax amounts are subject to the 10% early distribution penalty if you are under age 59½ at the time of the distribution and the conversion was less than five years ago. There are exceptions to the penalty such as disability or death. If you are over age 59 ½ you can immediately access your converted funds without worrying about the penalty. There is no five-year waiting period for you.
4. Qualified distributions of earnings are tax and penalty free. Earnings are the last thing distributed from your account. Your earnings are tax-free and penalty-free if the distribution is a qualified distribution. A qualified distribution is made after you have had any Roth IRA account for five years AND you over the age of 59½, you are disabled, you are taking the funds for a first-time home purchase, or the distribution is to your beneficiary after your death.
If your distribution of earning is not a qualified distribution, it will be taxable and subject to the 10% early distribution penalty unless an exception applies.
5. You are never required to take money out of your Roth IRA during your lifetime. If you have a traditional IRA, there will come a point where you will be required to take distributions from your account. These distributions called required minimum distributions (RMDs) are mandatory, regardless of whether you need or want the money.
With your Roth IRA, there are no such requirements. You are not required to take RMDs from your Roth IRA during your lifetime. However, your beneficiaries must take RMDs from their inherited Roth IRAs.
Copyright 2017 Ed Slott and Company, LLC