Tax Consequences of Roth IRA Distributions

by Herb Kirchhoff

A Roth individual retirement account allows you to build up a retirement fund without paying taxes on earnings and to make tax-free withdrawals from that fund when you reach retirement age, which --- according to the Internal Revenue Service --- is 59 1/2. The catch is that you may not deduct Roth IRA contributions from your income. You may take tax-free Roth IRA distributions before retirement age under certain circumstances.

Tax Free DIstributions

Roth IRA distributions are tax-free if paid to you after you turn age 59 1/2, are made because you have become disabled, or are paid to your spouse after your death. You also may take a tax-free early distribution of up to $10,000 from your Roth IRA for a down payment on your first home. These are called "qualified" distributions. The tax-free distribution rules apply if your Roth IRA has been open for at least five years. If the account was open for less than five years, you will owe a 10 percent penalty tax on any rollover contributions or IRA earnings included in your distribution.

Other Distributions

All other Roth IRA distributions are called "nonqualified" distributions. Some or all of your nonqualified distributions may be taxable. IRS ordering rules charge nonqualified distributions first to your direct out-of-pocket contributions to the Roth account, then to contributions from an IRA rollover, and lastly to IRA earnings. If you take an early Roth withdrawal less than or equal to your out-of-pocket contributions, there is no tax or penalty. If your early Roth withdrawal includes money from an IRA rollover that took place less than five earlier or from IRA earnings, you will owe a 10 percent penalty tax on those amounts, plus income tax on the earnings.

Penalty Exceptions

You may avoid any tax or penalty you would otherwise owe on an early Roth withdrawal if you take out the money to pay extraordinary medical expenses exceeding 7.5 percent of your annual income or to pay health insurance premiums after losing your job. You also would avoid tax on withdrawals to pay your college tuition, fees and related expenses such as books, equipment and supplies required for your course of study. You also avoid tax on distributions that are being paid out as an annuity in a series of equal payments over your lifetime, and --- if you are a military reservist --- on distributions connected with being called to active duty.

Other DIstribution Rules

Unlike with a traditional IRA, you are not required to take distributions from your Roth IRA when you turn 70 1/2. You may keep the money in your account and leave it as a tax-free legacy to your spouse. If you inherit a Roth IRA from your spouse, you will have no tax consequences if you make it your own by contributing money to it or rolling it over into your own Roth IRA. If you inherit a Roth IRA from someone other than your spouse, you won't owe income tax on the amounts representing the owner's contributions, but you will owe income tax on the amount representing earnings on those contributions.

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