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Roth IRA
Traditionally, retirement saving have been made on a pre-tax basis. Tax on contribution
and future earning are delayed until distribution. In contrast, with a Roth Retirement
account, the account owner pays tax on his contribution before it is made. At the time of
the distribution, if certain requirements are met, the entire distribution is free of income
tax. Moreover, an individual who have reached age 70 ½ is not eligible to set up a
traditional IRA, but there is no age limit to set up a Roth IRA. With a traditional
retirement plan, distribution are required to begin in the year the account owner reaches
age 70 ½ or the year after death, if earlier. In a Roth retirement account, distributions are
not required to begin at any ages if the owner is alive, so distributions may be deferred
Contribution to IRAs
Assuming an individual has earned income and otherwise meets the requirements for an
traditional IRA contribution, the most that can be contributed his/her IRA is the smaller
compensation of the year 1. This general limit may be increase to $8,000 if the individual
participated in a 401(K) plan maintained by an employer, and the employer went into
Generally, an individual can deduct the lesser of the two amounts: his/her contributions to
the traditional IRA for the year or the general limit. However, if an individual is an active
participant in a retirement plan at work, the IRA deduction is reduced where the
individual’s modified adjusted gross income exceeds the applicable dollar limit 2. The
deduction is also affected by the filing status of the individual. For 2009, the applicable
dollar limit is more than $89,000 but les than $109,000 for a married couple filing a joint
The contribution limit for Roth IRAs generally depends on whether contributions are
made only to Roth IRAs or to both traditional IRAs and Roth IRAs. If the contribution
are made only to Roth IRAs, the contribution limit is same the as the limit for traditional
IRAs. However, if contributions are made to both Roth IRAs and traditional IRAs, the
contribution limit for Roth IRA generally is the same as the limit would be if contribution
were made only to Roth IRAs, but then reduced by all contributions for the year to all
IRAs other than Roth IRAs 3. This means that the contribution limit is the lesser of: 1)
$5,000 ($6,000 if age 50 or older) minus all contributions for the year to all IRAs other
than Roth IRA, or 2) individual’s compensation minus all contributions for the year to all
Contribution to Roth IRA is not deductible 4 and there is no age limit for the
contribution.. Moreover, contributions are not allowed if adjusted gross income exceeds
$110,000 for single taxpayer and $160,000 for married filling jointly. These amounts are
indexed for inflation beginning in 2007. IRC 408A(C). In 2009, the amount is $116,000
Section 408(d)(1) provides that any amount paid or distributed out of an individual
retirement plan shall be included in gross income by the payee or distributee, as the case
may be, in the manner provided under Section 72. This means that, except for amounts
that are timely rolled into another eligible tax-deferred vehicle, for example, to another
IRA, distribution from an IRA are treated as ordinary income and includible in income
Section 408(d) (2) set forth three Special rules for applying Section 72: 1) all individual
retirement plans shall be treated as 1 contract, 2) all distributions during any taxable year
shall be treated as 1 distribution, and 3) the value of the contract, income on the contract,
and investment in the contract shall be computed as of the close of the calendar year in
The owner of an IRA is deemed to have a zero basis in the IRA, so distribution is fully
constitutes a return of the owner’s basis and thus is returned tax free. Unfortunately,
except for certain rollover situations, a taxpayer cannot withdraw the nondeductible
contributions with tax basis, Notice 87-16 provides the formula below:
“Outstanding rollover” means any amounts distributed before year end, but rolled into
another IRA in the following year under the 60 rollover rule. When calculating the
nontaxable portion of distributions, the total fair market value of all traditional IRA the
individual owns must be included in the computation. An individual may not designate a
distributions during the tax year are to be aggregated and treated as one distribution both
for purposes of reporting the distribution as well for purpose of determining the
Example 1. Jane, age 60, has four traditional IRA accounts; their fair market values at
Account FMV
1 $30,000
2 16,000
3 33,000
4 10,000
Total $89,000
Jane has made nondeductible contributions totaling $10,000 to account #4. He has made
nondeductible contribution from account #4. Jane cannot withdraw the nondeductible
portion (basis) before withdrawing the amounts treated as taxable income. He must
include the value of all IRA accounts in calculating the nontaxable portion of the
$10,000
$79,000 + $10,000
taxable income, even though the value of account #4 was made up entirely from
nondeductible contributions.
In period of tough economic times and falling investment performances, one of the
questions that invariably arises is whether losses in an IRA can be recognized by the
owner. It is possible for an individual to recognize a loss in the year an IRA is liquidated.
If the basis in the account exceeds the total value of IRA distributions in the final year, a
loss is recognized on the IRA distribution; see Notice 89-25 .The taxpayer may recognize
a loss only when all amounts in all IRAs have been distributed, and total distributions are
less than unrecovered basis; see Notice 87-16. Moreover, the ability to claim any such
loss is subject to the 2% of adjusted gross income limit that applies to miscellaneous
itemized deductions.
Planning strategy
Individuals who have taken a distribution from nondeductible traditional IRA are
contemplating rolling over a lump-sum distribution from a qualified plan into an IRA. If
possible, they should consider deferring the rollover into the following year. This will
keep the IRA account balances lower during the distribution year, thus allowing a higher
basis calculation for the distribution form the nondeductible IRA and lowering the
All individuals who have made nondeductible contributions should have filed copies of
Form 8606, Nondeductible IRAs, for each year such contribution were made. If the
individual failed to file Form 8606 to report nondeductible contributions, the contribution
is presumed to have been deductible. However, this presumption can be rebutted with
satisfactory evidence that the contributions were nondeductible. Copies of prior year
The potential for an IRA contributor to increase his or her retirement income can be
significant, as all income and realized gains in the account are accumulated tax-deferred.
contributions and distributions should not deter a taxpayer from making nondeductible
1. Qualified distributions
However, if the individual satisfies the requirements, qualified distributions from Roth
c. made to a beneficiary or to the estate of the individual after the death of the
individual
d. used to purchase or rebuild a first hom for the individual or a qualified family
The 5 year period begins on the first day of the individual’s tax year for which the first
regular contribution is made, or if earlier, the first day of the individual’s tax year in
which the first conversion contributions is made to any Roth IRA of the individual. The
period ends on the last day of the individual’s fifth consecutive tax year beginning with
the tax year described previously. If the distribution is made to a beneficiary of the estate
of the owner, the period held by the decedent is included in the period held by the
beneficiary to determine whether the 5-year period is satisfied (408A(d)(2)(A) and Reg.
§1.408A-6, Q&A-1(b)).However, generally this tacking rule does not impact the holding
period of other Roth IRA owned by the beneficiary. So the five year period for an
determined independently of the five-year period for the beneficiary’s own Roth IRA.
There is, however, one exception. If the surviving spouse treat the Roth IRA as his or her
own, the five year period with respect to the surviving spouse’s Roth IRA ends at the
earlier of the five year period end of either the decedent or the spouse’s own Roth IRA.
2. Nonqualified distributions
If the Roth IRA distribution fails to meet either one of the two requirements for qualified
distributions, the taxpayer is not subjected to double taxation. The amount contributed is
not subject to tax since taxpayers paid tax on contributions, only the earnings in excess of
that amount are taxed. Nonqualified distributions are taxable to the extent the amount of
the distributions, added to all prior distributions less prior amounts that were includible in
income, exceed the direct Roth contributions. Thus, the taxpayer is generally allowed to
Further, where the distribution does not constitute a qualified the distribution, the 10%
early distributions tax of Section 72(t) applies to amounts includible in income. If, within
the 5-year period starting with the first day of the tax year in which an individual first set
up and contributed to a Roth or convert an amount from other qualified retirement plan to
a Roth IRA, he/she takes a distribution from a Roth IRA, he/she may have to pay the
10% additional tax on early distribution unless one of the exceptions is met.
The 5 year period used for determining whether the 10% early distribution tax applies to
a distribution from a conversion is separately determined for each conversion, and is not
necessarily the same as the 5 year period used for determining whether a distribution is a
qualified distribution.
Example 2. Jane makes a conversion contribution on March 25, 2009, and makes a
regular contribution for 2008 on the dame date. The 5 year period for the conversion
begins January 1, 2009, while the 5-year period for the regular contribution begins on
January 1, 2008.
The tax implication of a nonqualified distribution depends on the source of the Roth IRA
assets. To determine the source of assets distributed from a Roth IRA, the IRS uses the
'ordering rules'. According to the ordering rules, assets are distributed from a Roth IRA in
the following order (once assets from one source run out, the assets from the next source
are distributed):
Distributions of Roth IRA assets from regular participant contributions and from
nontaxable conversions of Traditional IRA can be taken at anytime, tax and penalty free
if the distribution is in line with the rules that exempt assets from income tax and early-
penalty.
Example 3. Jane established his first Roth IRA in 2000 and made a participate
contribution of $2,000 a year. In 2004, he converted his traditional IRA to his Roth IRA.
In 2005, john is 55 years old, and balance is John’s IRA at that time is represented as
follows:
Assets Source
$10,000 Roth IRA participant contributions 2000 through 2004
$50,000 Taxable Traditional IRA conversions from 2004
$10,000 Non-taxable Roth IRA conversions from 2004
$5,000 Earnings
$75,000
If John takes a distribution of $75,000, the first $10,000 comes from his regular Roth IRA
contributions and is therefore tax and penalty free. The additional $50,000, however, comes from
his taxable conversion assets. Because these assets were taxed when converted, there will not
be any income tax owed on the distribution. However, they are subjected to the 10% early-
distribution penalty since it hasn't been five years since John's conversion. But, the penalty may
still be waived if John meets one of exceptions above. The additional $10,000 is attributed to
nontaxable conversion assets. These will not be subjected to taxes or the early-distribution
penalty because no deduction was allowed when they were contributed to the Traditional IRA.
Finally, the earnings of $5,000 will be subjected to taxes and the 10% early-distribution penalty
the distribution is nonqualified distribution and doesn’t meet one of the exceptions.
The following chart summarizes the tax treatment of all possible Roth IRA distributions:
3. Planning Strategy
dependent upon the individual’s modified adjusted gross income. However, the adjusted
2010: the IRA owner will have the option to spread the income realized from a 2010 Roth
conversion over the following two years, half in 2011 and half in 2012. Other
considerations will go into the decision whether to convert. One of the important
questions is whether the individual needs the IRA funds for living expenses. One of the
greatest benefits of the Roth is the ability to avoid the lifetime required minimum
distribution. Those individuals who do not need the IRA assets for living and who would
prefer to leave IRA assets to another generation will likely wish to consider the
conversion option.
Some with earned income who has already reached age 70.5 is prohibited from making a
traditional IRA contributions, but not for a Roth IRA contributions. He would consider
A teenager with modest earnings would be well advised to contribute up to the maximum
to a Roth IRA when the tax cost of doing so is low on non-existent. A parent, who wants
to encourage good saving and investment habits, might make a corresponding gift to the
child.
Many taxpayers experience years with low taxable income, perhaps as a result of
The required minimum distribution rules are designed to ensure that funds in tax-
qualified retirement plan or a traditional IRA are actually used for retirement, rather than
for estate planning purposed. If an individual doesn’t need the funds for currently living,
the scenario is that the individual would defer distribution as long as possible to take
individuals who have reached the age of 70 ½ must take a certain amount of money out
of their qualified plans every year. The penalty for failing to do so is 50% of the
difference between what was distributed and what ought to have distributed according to
IRS rule. The Roth IRA is not subject to the pre-death required minimum distribution.
Distributions from a qualified plan or a traditional IRA are generally required no later
than the participant’s required beginning date. The required beginning date depends on
whether the plan is a qualified plan or an IRA and, in the case of a qualified plan, whether
If the individual in a qualified plan is not a 5% owner, the required beginning date means
April 1 of the calendar year following the later of: 1) the calendar year in which the
employee attains age 70 ½, or 2) the calendar year in which the employee retires.
In the case of a 5% owner in a qualified plan, the required beginning date means April 1
of the calendar year following the calendar year in which the employee attains age 70 ½ .
treated as a 5% owner if the employee is a more than 5% owner of the employer with
respect to the plan year within the calendar year in which the individual attains age 70 ½ .
Once distribution has begun for a 5% owner, distribution must continue in subsequent
Even though the first distribution must be made by April 1 of the year the participant is
So if an individual defer the first distribution into the second year, he/ she will have 2
The minimum amount distributed is determined by taking the value of the account as of
the last valuation date immediately preceding calendar year and dividing it by applicable
distribution period. The applicable distribution period is determined using the Uniform
Lifetime table set forth in the regulations. Essentially, the minimum amount is
expectancy determined by the Uniform Lifetime Table. The only exception for the use of
Uniform Lifetime Table is where the participant’s spouse is the sole designated
beneficiary and the spouse is more than 10 years younger than the participant. The
participant may use another table that takes into account the actual joint life expectancy
While the distribution process is fairly standardized, it still lend to some planning
designate the spouse as the sole beneficiary, thus use the more advantageous joint table to
defer the distribution. Next, thought should be given when the first required minimum
distribution in the year following the year in which he/she attains age 70 ½, the individual
will be forced to take two distributions that year: one by April and other by December 31.
This might push the individual to a higher tax bracket. If that is the case, the individual
might consider taking the first distribution in the calendar year in which the individual
reaches age 70 ½. Once the first distribution is satisfied, the taxpayer can decide when to
take each subsequent year’s required minimum distribution. Generally, individual can
take only one distribution at the end of the year in order to better allow the earning to
The required Minimum distribution after the owner’s death depends on whether the
beneficiary is the owner’s spouse, a designated beneficiary other the owner’s spouse, or if
there is no designated beneficiary. For the most par, Required Minimum distribution after
an owner’s death are determined based on Table V of the 72 regulations and beneficiary’s
age is used.
If the spouse is the sole designated beneficiary, there are tow options available to the
spouse. The spouse may leave the assets in the owner’s account or rollover the assets in
to the spouse’s own account. The exact distribution requirements depend on whether the
If the owner dies before required beginning date and the spouse chose to leave the fund in
owner’s account, The distributions should be made using the Table V Divisor for the
owner’s (may use surviving spouse’s age if younger) each year, recalculated annually.
The distribution must begin by December 31 of the year the owner would have attained
age 70 ½. If the surviving spouse dies before distribution to the surviving spouse have
begun, use the Table V divisor for designated beneficiary named by the surving spouse,
It is usually advisable for surviving spouse to leave the fund in owner’s account if the
owner is actually younger than the surviving spouse. However, if the surviving spouse is
younger the owner, it is advantage to roll over the owner’s account into the spouse’s
account. So the distribution should begin by the spouse’s required beginning date and be
calculated based on the spouse’s life expectancy using the divisor form the uniform
distribution table.
If the owner dies after required the beginning date and the surviving spouse chose to
leave the fund in owner’s account, the distribution should be made as follows: the
owner’s required minimum distribution for the year of death should be distributed;
distributions of the balance should be made using the Table V divisor for the owner’s age
each year (may use surviving spouse’s age if younger). Distributions are recalculated
annually and must begin by December 31 of the year following the owner’s death. If the
surviving spouse dies before distributions to the surviving spouse have begun, use the
Table V divisor for ht e designated beneficiary named by the surviving spouse, as if the
Similarly, it is better to roll the owner’s account into the surviving spouse’s account if the
spouse is younger than the owner. Then the distribution should begin by the surviving
spouse’s required beginning dated and be calculated based on the surviving spouse’s life
expectancy using the divisor form the Uniform Distribution table. If the owner dies after
the owner’s required beginning date, the surviving spouse must also take the own’s
required distribution for the year of the owners’ death. Prop. Reg. 1.402(c)-2, A-12
(2001)
Distribution must be made by December 31 of the year following the owner’s death to
the designated beneficiary over the designated beneficiary’s life expectancy. The
calculation should use Table V divisor based on oldest designate beneficiary’s age in the
calendar year after participant’s death, reduced by one for each year thereafter. In
addition, if the account owner dies after his required beginning date, the owner’s required
C. No designated beneficiary
If there is no designated beneficiary, and if the owner has not reached the required
beginning date, the account must be distributed by December 31st of the fifth year
following the account owner’s death. If the owner has reached the RBD, then the account
must be distributed over the owner’s nonrecalculated life expectancy based on the
owner’s age in calendar year of the owner’s death, reduced by one for each year after the
While the required minimum distribution rules are there to prevent individuals from using
tax-deferred amount for estate planning purpose rather than for actual retirement, the
early distributions tax of Section 72(t) is to prevent individuals form receiving tax-
preferred retirement income too early and for non-retirement purposed. There is generally
a 10% penalty tax on retirement income includible in income which is paid before an
individual attains age 59 ½. The 10% is in addition to any other tax otherwise due and
applies unless taxation is avoided by rolling the amount into another eligible tax-deferred
If an individual in a qualified plan does not elect direct rollover, he/she would be subject
to the 20% federal income tax withhold. If the individual subsequently rolls over the
distribution actually received within 60-day rollover period, the 10% penalty tax will still
apply to the 20% withheld and not received if the individual is under age 59 ½.
Despite the general rule, the early distribution tax is subject to a number of exceptions:
72(m)
made for the life or life expectancy of the employee or the joint lives or joint life
• Distribution paid with respect tot stock of a corporation that are described in
Section 404(k)
• Distribution made to the employee to the extent such distribution do not exceed
the amount allowable as a deduction under Section 213 to the employee for