At all times and at any age, you can withdraw as much as you have contributed to your Roth IRA without tax or penalty. Unfortunately, keeping track of how much you have contributed is complicated. First, there is no convenient place to keep track of regular Roth IRA contributions. Instead, you need to maintain your own records. Second, there are many different ways that assets can be added to a Roth IRA and each one adjusts your Roth contribution basis slightly differently.
In this series, I am reviewing each type of contribution one at a time and explaining how much counts as Roth contribution basis and when. This article is putting some of the pieces together by explaining step-by-step an example the IRS gives in Publication 590B.
In Publication 590B, the IRS gives an example to demonstrate how Roth distribution ordering works. That example is:
On October 15, 2016, Justin converted all $80,000 in his traditional IRA to his Roth IRA. His Forms 8606 from prior years show that $20,000 of the amount converted is his basis.
Justin included $60,000 ($80,000 − $20,000) in his gross income.
On February 23, 2020, Justin made a regular contribution of $5,000 to a Roth IRA. On November 8, 2020, at age 60, Justin took a $7,000 distribution from his Roth IRA.
The first $5,000 of the distribution is a return of Justin’s regular contribution and isn’t includible in his income.
The next $2,000 of the distribution isn’t includible in income because it was included previously.
The first funding we are told about is an $80,000 Roth conversion four years ago. The $20,000 of that Roth conversion is a conversion of a nondeductible basis while the remaining $60,000 was taxable in 2016 as a Roth conversion.
Then in 2020, he contributed $5,000 to his Roth IRA. This makes his total regular contribution basis $5,000 and his total rollover contribution basis $80,000.
Here’s a summary of what Justin did:
|Years Ago||Year||Amount||Action||Regular Contribution||Rollover Contribution|
|4||2016||$60,000||Roth conversion (taxable portion)||$60,000|
|4||2016||$20,000||rollover of nondeductible basis (nontaxable portion)||$20,000|
In 2020, Justin withdrew $7,000.
A qualified distribution is when the distribution is made 5-years after the tax year of your first Roth IRA contribution AND when you are either older than 59 1/2, disabled, or dead. The example tells us that Justin is age 60 but his first Roth IRA contribution was in 2016, only four years ago. This means that his $7,000 distribution is non-qualified, so he needs to see if he is withdrawing only from contribution basis or if any of his withdrawal is sourced from earnings.
Withdrawals come first out of your regular contribution basis, so $5,000 of that $7,000 is a return of his regular contributions. As a result, it does not matter how old Justin is, why he withdrew the funds, or anything else; that $5,000 is not taxable, not included in income, and not subject to any early distribution penalty.
After having used up his regular contribution basis, his next withdrawal comes from the taxable portion of his oldest Roth conversion. His oldest Roth conversion is the one from 2016. This means the next $2,000 comes out of the rollover contribution basis of the taxable portion of his 2016 Roth conversion. Because he has sufficient rollover contribution basis this next $2,000 is also not taxable and not included in income.
Because he made a non-qualified withdrawal from a rollover contribution basis less than five years old, he needs to check if any of it is a recapture amount. At age 60, Justin is over age 59 1/2. This means that his distribution is not an early distribution and he will not be faced with a recapture amount early distribution penalty.
Of note here: If it were subject to recapture, only the taxable portion of your Roth conversion or rollover must be included as a recapture amount. Any nontaxable amount, such as nondeductible basis converted or rolled over, is not included in the recapture amount.
If he had withdrawn the full $85,000 of his total contribution basis, the full amount still would not be included in income because he would have sufficient contribution basis to cover the full withdrawal. Because he is older than 59 1/2, none of it would be subject to recapture either. However if he were younger than age 59 1/2, $60,000 of it would be included in the recapture amount on Form 5392.
As the instructions for Form 5329 state:
Generally, an early distribution is allocated to your Roth IRA contributions first, then to your conversions and rollovers on a first-in, first-out basis. For each conversion or rollover, you must first allocate the early distribution to the portion that was subject to tax in the year of the conversion or rollover, and then to the portion that wasn’t subject to tax. The recapture amount is the sum of the early distribution amounts that you allocate to these taxable portions of your conversions or rollovers.
This means the order of withdrawals is:
- regular contribution basis, which is never taxed and never subject to penalty;
- the taxable portion of your oldest Roth conversion;
- the nontaxable portion of your oldest Roth conversion;
- repeating numbers 2 and 3 on your next oldest Roth conversion;
- and then finally Roth IRA earnings, the portion not attributable to any kind of contribution basis.
The taxable portion of Roth conversions you did under five years ago are the only portion of your contribution basis which are subject to the early distribution penalty from the recapture amount. Waiting for your Roth conversions to be over 5 years old or you are older than age 59 1/2 is the easiest way to avoid the early distribution penalty on it.
The Roth withdrawal rules are more complicated than they first appear, but funding your Roth IRA still remains one of the best financial decisions you can make.
Photo by Linda Söndergaard on Unsplash