Roth distribution

[oceanlovin'ea]

The tax book says these are the rules for distributions from a Roth IRA
"5-Year Rules for Roth IRAs
There are two separate 5-year rules that apply to Roth IRAs.
• The 5-year holding period to qualify for tax-free distributions.
• The 5-year holding period to avoid the 10% early withdrawal
penalty.
Tax-free distributions. For a distribution from a Roth IRA to
qualify for tax-free treatment, the distribution must be made after
the 5-year period beginning on the first day of the tax year for
which the taxpayer first contributed or converted money into a
Roth IRA and ending on the last day of the fifth consecutive year."

These dates are actual calendar years. Is that correct? For example, if a person put money into a Roth IRA in September of 2006 and took the money out in January of 2011, they would qualify for tax free distribution. It would count from Jan 1 of 2006, that would be the first year. 2007 would be the second year. 2008 would be third. 2009 would be fourth and 2010 would be the fifth year.

Am I calculating this correctly? I have not had this situation before. Very few of my clients ever put money into Roth IRAs. Client took money out in 2011. I will have her search her records or call the company and see when she put the money in.

Thanks for the help.

Linda, EA

[appelman]

Yes, you are reading it right.

The rules are different, but the 5-year period is the same. A qualified distribution must meet the 5-year test and one of several additional conditions. However, a non-qualified distribution will not be subject to penalty if it meets one of a number of exceptions.

[oceanlovin'ea]

Client was not age 59 1/2. But the money was in the Roth IRA for over 5 years. But none of the exceptions to the penalty apply.

The initial contribution can't be taxable because it was not an adjustment to income when it was put in. It was money that had already been taxed. So are just the earnings taxable? How do you figure the penalty? It sounds like it should be on the whole amount.

Example: Client put $4000.00 in a Roth IRA in 2005. Client cashes in the IRA in 2011 and the amount of money that they get is $4500.00. My reasoning is the earnings of $500 are taxable and subject to the penalty.

Am I correct in my thinking?

Linda, EA

[appelman]

You've got it!

That's the way I would interpret it.

[manyhappyreturns]

What if the TP is 50 years old and takes a distribution before the 5 years are up? Does he need to pay tax on just the earnings portion, or the whole amount, even though the money was pre-taxed. IRAs are really confusing for me, and the IRS publications on the subject are a bit vague sometimes.

[ruthc]

See Article Below

The below article really has helped me understand how the Roth really works. Hope ithelps you too!

http://fairmark.com/rothira/taxfree.htm

[John of PA]

General Rule, no exceptions, you can always withdrawl from your Roth what you put into it, tax free (your basis in the Roth). It could be subject to a 10% penalty, but it's always tax free, that is the basis before earnings.