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Determining Tax on Roth IRA Distributions in 5 Easy Steps Thumbnail

Determining Tax on Roth IRA Distributions in 5 Easy Steps

What are the ordering rules?

Roth IRA distributions can consist of contributions, converted funds and earnings – or any combination of the three. To determine what your distribution is, you must use “ordering rules” which dictate the order in which these categories of Roth IRA money must be withdrawn. All Roth IRAs are considered one Roth IRA for distribution purposes. A Roth IRA distribution will consist first of any Roth IRA contributions. If there are no contributions or those amounts are completely exhausted, the next funds out are converted funds. Once all converted funds have been exhausted, the remainder of the distributions will consist of earnings.

Roth IRA distributions are taxed in many different ways depending on if they are contributions, converted funds, or earnings. Read to see what your ordering rule would be.

1. Are you withdrawing a contribution? Roth IRA contributions are the annual amounts that you contribute to a Roth IRA account. A distribution of Roth IRA contributions will always be both tax and penalty free.

2. Are you withdrawing converted amounts before age 59 ½? Converted funds are never subject to income tax. However, they will be subject to the 10% penalty for early distributions (unless an exception applies) if you are under 59 ½ and they have been in a Roth IRA for less than five years. Each conversion starts its own 10% penalty 5-year clock, and the converted amounts are withdrawn on a first-in, first-out basis.

3. Are you withdrawing converted amounts after 5 years or age 59 ½? A distribution of converted funds after 5 years or after age 59 ½ will be entirely income tax and penalty free.

4. Are you withdrawing earnings before age 59 ½? Earnings withdrawn prior to age 59 ½ are generally subject to income tax regardless of how long they’ve been in a Roth IRA account. Earnings withdrawn prior to age 59 ½ are also generally subject to the 10% penalty for early distributions unless an exception applies.

5. Are you withdrawing earnings after age 59 ½ and 5 years? Earnings withdrawn after age 59 ½ are never subject to the 10% penalty. They may, however, be subject to income tax. If you have held any Roth IRA for more than 5 years, your earnings are tax free. If not, they are taxable at ordinary rates.

By Christian Cordoba
Founder, California Retirement Advisors

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Investment advisory services offered through Mutual Advisors, LLC DBA California Retirement Advisors, a SEC registered investment advisor. Securities offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license #0B09076. This content is developed from sources believed to be providing accurate information and provided by California Retirement Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. California Retirement Advisors, nor any of its members, are tax accountants or legal attorneys and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional.