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Advising Clients On Roth IRA Withdrawals: What Every RTRP Should Understand


Roth IRAs are all the rage these days, thanks largely to a marketing blitz that has painted this investment instrument as one of the best long-term retirement strategies on the market today.  Studies show that compared to just five years ago, American taxpayers are as likely to establish a Roth IRA than they are to invest in a 401(k) account. This is an investment trend that many enrolled agents have observed firsthand in their roles as a registered tax return preparer.  What the enrolled agent also knows, as a corollary to this trend, is that an increasing percentage of Roth IRA account holders will need make withdrawals from these accounts at some point.  The rules governing such withdrawals are clear, as any RTRP learns through years of tax CPE courses, and must be followed carefully to ensure taxpayers avoid penalties that could end up costing them.

Among taxpayers there is a still a great deal of confusion around when one is able to withdraw money from a Roth IRA. Is it after 3 years, or 5?  Is it at age 60? Below is quick recap of the core rules surround early withdrawals that will helpenrolled agents field these common questions.

Taxpayers can withdraw contributions year-round

The simple answer is that there is neither a tax nor a penalty for withdrawing IRA contributions. However, clients should be advised to maintain a spreadsheet of yearly contribution amounts year that will enable the tax preparer to calculate the total value of the contributions. When a withdrawal is made, according to the IRS, it is as if the sum  withdrawn came out of the taxpayer’s contributions first (which is different from a traditional IRA).

Qualified withdrawal of earnings permissible after five years

Any RTRP should advise clients that this five-year clock begins ticking on 1st of January in the tax year of the very first contribution. For example, if a client established a Roth IRA in 2007,  then January 1, 2012 is the date when this threshold will be met. The five-year period begins in the year of the IRA’s initial contribution, conversion or rollover. Once the time required has passed, it is complete for all the taxpayer’s Roth IRA contributions.

In addition, taxpayers must meet at least one of the following qualified distribution reasons around withdrawals:

  1. Be age 59.5
  2. Beneficiary after the account holder dies
  3. Disabled
  4. Going to school at a qualified higher education institution
  5. Un-reimbursed medical expenses
  6. Frst time homebuyers
  7. Series of equal payments (SEPP).

Withdraw taxable conversions after five years

Enrolled agents should advise clients that money put into a Roth IRA from a traditional IRA is able to be withdrawn, both tax-free and penalty-free, after a period of five years, although conversions made in different tax years must satisfy a separate 5 year period.

However, it is important to note that converted Roth IRAs withdrawn before this requisite period may result in the taxpayer being slapped with a 10% early penalty. This is an exception to the above rule that uses one five-year time period to satisfy all Roth IRAs.

Withdrawing nontaxable conversions at any point

If a taxpayer has converted money from a traditional IRA to a Roth IRA, and hasn’t taken a deduction at the time of the contribution to the traditional IRA, this withdrawal, too, is both tax and penalty-free.

Staggering Roth IRA Withdrawals

As enrolled agents well know, even though individuals are able to access Roth IRAs tax and penalty-free in a number of ways, their withdrawals must follow a set order. The basic rule of thumb is that all Roth IRAs are considered as one Roth IRA for the withdrawal order:

-- Regular Roth IRA contributions

-- Taxable rollover conversions

-- Nontaxable rollover conversions

-- Repeat of steps 2 & 3 for each conversion

-- Earnings

IRS Circular 230 Disclosure

Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.

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