Tax Free Distributions From a Roth IRA - Rodgers & Associates

Tax Free Distributions From a Roth IRA

The Roth IRA is a key piece of the New Three-Legged Stool strategy of retirement planning because it repre­sents the tax-free leg of the stool. However, a distri­b­ution from a Roth IRA is not tax-free unless it is a “qualified” distri­b­ution. Qualified distri­b­u­tions from Roth IRAs are tax and penalty free, but non-qualified distri­b­u­tions may be subject to tax and an early distri­b­ution penalty.

A distri­b­ution is qualified once the Roth IRA owner has reached age 59 ½ and the Roth account is at least five years old. There are three excep­tions:

  • First home buyer. The distri­b­ution is used toward the purchase, or to build or rebuild a first home for the Roth IRA holder or a qualified family member. This is limited to $10,000 per lifetime.
  • Disability. The Roth IRA holder becomes disabled.
  • Death. Distri­b­u­tions are made to the benefi­ciary of the Roth IRA holder.

Non-qualified distri­b­u­tions not meeting the above require­ments may be subjected to income tax and/or the 10% early-distribution penalty. The deter­mining factor is the source of the distri­b­ution.

  • A regular after-tax contri­bution: never taxed or penalized.
  • Conversion of taxable assets from a tradi­tional IRA or rollover of taxable assets from a company plan: assets are taxed when the conversion occurs. Penalty waived after five years have passed.
  • Conversion of after-tax assets from a tradi­tional IRA or rollover of after-tax assets from a company plan: never taxed or penalized.
  • Earnings: taxable and subject to penalty if under age 59 ½.

The IRS uses “ordering rules” to determine the source of assets distributed from a Roth IRA. Once assets from one source are used up, the assets are deemed to be distributed from the next source to determine tax and/or penalty. Here is the order in which the IRS deter­mines the source of distri­b­u­tions:

  1. Regular Roth IRA contri­bu­tions.
  2. Taxable Tradi­tional IRA conver­sions and taxable rollovers from a company plan.
  3. Nontaxable Tradi­tional IRA conver­sions and nontaxable rollovers from a company plan.
  4. Earnings.