Do you have a Roth IRA? If you do, there will very likely come a time when you want to take a distribution from that account. The distribution rules for taxation of Roth IRA distributions can be complicated, but if they are followed, the reward is tax-free withdrawals in retirement.
Here is what you need to know:
Aggregation
Things can get a little confusing 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 your Roth IRAs are considered one account for tax purposes. Your IRA custodian reports 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.
Tax-Year Contributions
Amounts up to the total of your Roth IRA contributions are considered to be 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 amounts equal to your contributions tax and penalty-free. Maybe, for example, you contributed to your Roth IRA in 2018, and you are now 32 years old and need that money. You will not be taxed or subject to penalty when the amount of that contribution is distributed. It doesn’t matter that you are not yet age 59½ and it doesn’t matter how you use your money.
Converted Amounts
Amounts up to the total of your Roth conversions are considered to be distributed next on a first-in, first-out basis. If you converted both pre- and after-tax amounts, the amount of your pre-tax amounts is distributed first. Distributions of amounts equal to your conversions 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 59½, you can immediately access the amount of your converted funds without worrying about the penalty. There is no five-year waiting period for you.
Earnings
The remaining portion of your Roth IRAs are considered earnings and are the last thing distributed from your account. Those amounts 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 are 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 amounts equal to earnings is not a qualified distribution, it will be taxable and subject to the 10% early distribution penalty, unless an exception applies.
Tax-Free Distributions in Retirement
You are not required to take any distributions from your Roth IRA during your lifetime. Unlike traditional IRAs, Roth IRAs are not subject to the lifetime required minimum distribution rules. However, if you do decide to withdraw funds, a qualified distribution will be completely tax-free and not included in adjusted gross income. By taking a qualified Roth IRA distribution, you can therefore avoid the stealth taxes that hit many retirees hard, such as taxation of Social Security benefits or Medicare surcharges when income rises in retirement.
Specializing in private wealth management, we provide education, guidance, and strategies to help you achieve a tax-efficient retirement income.
Specializing in private wealth management, we provide education, guidance, and strategies to help you achieve a tax-efficient retirement income.
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