When are Roth IRA distributions taxable?

When are Roth IRA distributions taxable?

From Ken in Satellite Beach: I thought once you turned 59 ½ Roth IRAs are tax free but a 63 year old co-worker insists he had to pay some tax last year when he withdrew from his Roth IRA. What gives?

Ken, it is possible to owe taxes on a Roth IRA distribution. However, most people can easily avoid doing so by navigating two five-year rules.

The first states that if you distribute amounts that were converted to the Roth IRA less than five years after the conversion and you are under age 59 ½, a penalty of 10% of the distribution will apply. This rule applies to each conversion separately. Your co worker is over 59 ½ so this rule is not the issue.

The second five-year rule could be the culprit. It states that earnings withdrawn within 5 years of the opening of a taxpayer’s very first Roth IRA are taxable, regardless of the taxpayer’s age. If under 59 ½ a 10% penalty is also assessed. Once it has been five years since the opening of the first Roth IRA and the owner reaches age 59 1/2, this rule is no longer an issue even if the original Roth IRA no longer exists and all distributions would be tax-free.

Ideally Roth IRAs are left alone to grow over time and not used until needed after retirement…

Ideally Roth IRAs are left alone to grow over time and not used until needed after retirement but if cash is needed, some funds can be accessed tax free at any time. How much is dependent on how the account was funded and the rules regarding distributions.

When you distribute any funds from a Roth IRA, a set of ordering rules applies.

  1. The first dollars out are deemed to be from your regular contributions. Since contributions are made after-tax, these withdrawals are tax-free.
  2. Once you have distributed the equivalent of the total amount of your contributions, the next dollars out are deemed to be amounts converted more than 5 years ago. You would have paid the tax at time of conversion, so no taxes are due upon withdrawal for the account. Since these converted amounts are more than 5 years old, the five-year rule applicable to conversions is satisfied and no penalty is due on these distributions either.
  3. Next out are amounts converted less than 5 years ago. You would have paid tax at time of conversion but not paid the 10% penalty that normally applies to amounts coming out of an IRA prior to age 59 ½. So, if you take out more than the contributions in #1 and the older conversions in #2 and are still under 59 1/2, you pay the 10% penalty when you get to these converted funds.
  4. The last thing out after taking all prior contributions and conversions is by default deemed to be the earnings. The second five-year rule is a factor here. For the earnings to be tax-free, you must be at least 59 ½ and it must have been at least five years since you opened your first Roth IRA.

So, say you made $20,000 in contributions over the years, converted $30,000 six years ago, another $30,000 two years ago and the account is worth $90,000. The first $20,000 you take is tax free (#1 above) as is the next $30,000 (#2). The next $30,000 (#3) removed is tax and penalty free, if you are over 59 ½. If you are under 59 ½, you’ll owe a $3,000 penalty (10% of $30,000). The last $10,000 is earnings and is taxed based on item #4 above.

The accounting for this is done on IRS Form 8606 whenever you make a contribution, conversion or distribution until both five year rules are satisfied.

Making News…

We continue to help various media outlets provide sound information to their audiences. (Some links may require a subscription to view.)

Casandra Garrett, CFP with Moisand Fitzgerald Tamayo

Casandra Garrett, CFP®

Charlie Fitzgerald, CFP®, Derrick Chandler, CFP®,  Tommy Lucas, CFP® EA and Casandra Garrett, CFP® participated in a call-in event on October 16 for the Orlando Sentinel. The Sentinel has highlighted several of their responses in its “Ask An Expert” feature over the last quarter. Tommy explained how some can avoid the 10% penalty for early retirement withdrawals while Casandra Garrett, CFP® suggested one way to teach youngsters a little about markets and how to consolidate multiple IRAs into one.

DJ Hunt, CFP® wrote Secure Act 2.0 Creates Big Benefits for Small Businesses for Rethinking65, a publication for advisors working with clients that are retired or soon will be.

Dan Moisand,CFP® continues to write for MarketWatch and Florida Today.

Does a Roth conversion make good tax sense? Here’s how to decide – Florida Today

I want to contribute to an IRA. Do I earn too much? – MarketWatch

Are inherited Roth retirement accounts subject to RMDs? – MarketWatch

A taxing question: What should I do if I can’t file by April 18? – Florida Today

Will a charitable donation help offset my taxes? – MarketWatch

I’m 55 and need cash. Can I tap into my IRA without penalty? – MarketWatch

Opinion: Can I donate stock and get a tax deduction? – MarketWatch

IRAs, RMDs and charitable donations: How do I sort out this taxing alphabet soup?- Florida Today

Can I donate to a charity directly from my 401(k)? – MarketWatch

In the News…

MFT named to RIA Edge 100, Central Florida Fast 50 2023 and a “Best Place to Work”

Staff of fee-only financial planners Moisand Fitzgerald TamayoRIA Edge, a division of WealthManagement.com, named Moisand Fitzgerald Tamayo, LLC to its inaugural RIA Edge 100 list of America’s top firms. The list was compiled by Wealth Management IQ and Discovery Data. See detail on the list and methodology here.

The Orlando Business Journal named MFT to its Central Florida Fast 50 2023 as one of Central Florida’s fastest growing privately owned companies. The firms are ranked based on their percentage of consistent three-year revenue growth, between 2020-2022

And…for the fourth time in the last five years, Moisand Fitzgerald Tamayo has been named one of the 75 Best Places to Work for Financial Advisors by InvestmentNews.

Mike Salmom, CFP®, EA continues to help educate the commercial real estate community. Since February, he gave virtual presentations to Kinetic CRE Association, the Phoenix office of Kidder Mathews and Ashwill Associates. He also appeared on the Phoenix Commercial Inc Podcast and CRE Deal Room Podcast

If you are a member of an organization in need of a personal finance speaker, we are happy to talk with your group’s organizers about helping out at no cost.

Dan Moisand’s service as 2023 Chairman of the Board of Directors of CFP Board, the body that confers and administers the CERTIFIED FINANCIAL PLANNER™ and CFP® credentials for the 95,000+ CFP® professionals in the U.S. has him speaking at several events and conferences during the year. He recently spoke at the T3 (Technology Tools for Today) conference, the Spring meeting of the Financial Planning Association of New England, FPA Retreat and the Spring conference of the National Association of Personal Financial Advisors.

Tommy Lucas, CFP®, EA  provided financial tips for  CNBC reporters on the following topics: 3 ways to lower your 2022 tax bill or boost your refund – CNBC, If you need more time for your tax return, do this today or ‘miss the opportunity,’ pro warns – CNBCHow to pay 0% capital gains taxes with a six-figure income in 2023 CNBC, and This tax move is a ‘game changer’ for freelancers and gig economy workers, advisor saysCNBC.

Things We Found of Note

One interview two very different headlines  In a classic example of how publications can present events in very different ways, Warren Buffett gave a CNBC interview on April 14th. That day, referring to the exact same interview we spotted the following two headlines on yahoo!finance: “Warren Buffett Just Said More Banks Will ‘Go Bust’ — Is Your Money Safe?” and “Buffett: ‘Nobody is going to lose money on a deposit in a US bank'” While this example certainly shows how a publication can get your attention through positive or negative headlines, it is also a good reminder that if we have a positive or negative view of an issue, we can easily find headlines that will support our view.  


Notable Numbers

61.8%                   Students directly enrolled in college after high school in 2021. (Best Colleges)

21 million            Total enrolled college students in the United States in 2010. (Education Data Initiative)

16.2 million         Total enrolled college students in the United States in 2022. (Education Data Initiative)

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About Dan Moisand

Dan Moisand is a fee-only financial advisor with Moisand Fitzgerald Tamayo, LLC. He is a regular contributor for multiple outlets, including Florida Today, MarketWatch, and The Wall Street Journal. His writing and financial advice have also been featured in Financial Planning, Investment Advisor, Wealth Manager/Advising Boomers, Forbes, Smart Money, and The New York Times, among other publications. He is the only two-time winner of the Journal of Financial Planning’s “Call for Papers” competition and has been named a top financial planner and advisor by multiple publications. Investment News named Dan one of the “twenty most influential men and women” in the history of financial planning. He currently serves on the Board of Directors for the CFP (Certified Financial Planner) Board.


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