Benefit from Roth "ordering rules"

For the first time ever, taxpayers can convert a traditional IRA to a Roth, regardless of their annual income. Previously, conversions weren’t allowed for taxpayers with a modified adjusted gross income (MAGI) over $100,000.
But nothing has changed in the rules for Roth IRA distributions. Unless payouts are treated as “qualified distributions,” they are subject to tax.

Nevertheless, despite the common perception, the tax burden on taxable distributions may be less than you think. Some “taxable” distributions might be completely tax-free. The exact tax treatment depends on the “ordering rules” for Roth IRA distributions.
If a withdrawal meets the requirements for a qualified distribution, it is 100% exempt from tax. A qualified distribution is one that is made from a Roth IRA in existence for at least five years after reaching age 59 1/2, upon death or disability or used to pay first-time homebuyer expenses (up to a lifetime limit of $10,000).
All other distributions are nonqualified. Nonqualified distributions are treated as coming from Roth IRA assets in the following order:

  • Regular Roth IRA contributions
  • Taxable traditional IRA conversions
  • Nontaxable traditional IRA conversions
  • Earnings on Roth IRA assets

Because distributions are treated as coming first from Roth contributions, you   may be able to take out as much as you put in — at any time — without any dire tax consequences.
We can walk you through the “ordering rules” to minimize the tax liability, if any, for your particular situation. There may be additional complications for early withdrawals. We can provide the necessary guidance in this area. Contact us for more details and we will be glad to assist you.

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