Roth IRA withdrawals
What is the tax consequence for the following scenarios?
(A) Taxpayer withdraws from a “Contributed” Roth IRA account. The account was established 3 years ago with $3,000. The account is now worth $4,000. Taxpayer is 62, and is withdrawing the whole amount and closing the account. Is the $1,000 excess subject to income tax? Would it be subject to the 10% early withdrawal penalty tax? ❓
(B) Taxpayer withdraws from a “conversion”IRA account. The account was converted two years ago. The original conversion amount was $20,000, and is now $27,000. At the time of conversion, the account owner was 58. Now he is 60. If he wishes to take $25,000 distribution, how is the amount over and above the original basis taxed? Would the 10% penalty for early withdrawal apply, since he wasn’t yet 59-1/2 when he converted, and he hasn’t yet met the 5 year requirement now, although he IS older than 59-1/2 ❓
Permalink Submitted by Edward Czapor on Mon, 2007-11-12 18:55
(A) The earnings are subject to tax if no other Roth has been established for at least 5 years. No exceptions would apply. There would be no penalty since withdrawn after age 591/2.
(B) Same situation as in (A), where if no other IRA established for 5 years, then earnings are taxable. No penalty on the withdrawal since over 591/2. The 5 year rule for converted amounts subject to penalty no longer applies once age 591/2.
Ed C.
Permalink Submitted by Alan Spross on Mon, 2007-11-12 21:06
Ed is correct.
The key here is that you cannot consider ONLY the account from which the distribution is taken. You must consider all of the Roth account a taxpayer has. In this case, having an older account that was opened prior to 2003 would make both of these distributions fully qualified and therefore tax and penalty free.
If one other account meet the aging requirement, then these distributions follow the ordering rules and are taxed as Ed indicated.
Permalink Submitted by [email protected] on Tue, 2007-11-13 00:41
What if the taxpayer is under 59-1/2 and has satisfied the 5 year rule. Now he takes distributions. And the distribution amount is greater than what he has put in (i.e., “basis”). How would the excess be taxed? I realize the 10% early withdrawal penalty would apply. Thanks. ❓
Permalink Submitted by Alan Spross on Tue, 2007-11-13 01:30
These distributions are non qualified, and therefore the ordering rules apply in determining how the distribution is reported and taxed. After all regular and conversion contributions have been distributed, the earnings are distributed. In your example, the earnings would be both taxable and subject to penalty since taxpayer is under 59.5.
Form 8606, Part III is used to report all Roth distributions unless the IRA custodian codes the distribution as qualified (Code Q). But only the part that represents earnings ends up being taxed on line 15b of Form 1040.
It is still possible to have a qualified distribution under 59.5 in the event of the 10,000 first homebuyer exception, disability or death. To be a qualified distribution, taxpayer must meet the 5 year requirement plus ONE of the other requirements noted.
Unfortuneately, most taxpayers are not keeping tabs on their contributions and conversions less distributions made over the years, and are not going to be prepared to fill out the 8606 properly unless they wait until distributions are qualified, and then they won’t need the 8606.