Did you know that there is a specific order for distributions from your Roth IRA? The Internal Revenue Service has set up a group of rules to determine the order of money, by source, as it is distributed from your account. This holds for any distribution from a Roth IRA account.
Ordering rules
First, return of your annual contribution (or excess contribution) for this tax year. This means that if you’ve made a contribution to your Roth IRA in this tax year, the first money that you withdraw from the account will be the money that you contributed this year. If you over-contributed to your account for a prior tax year, growth on this over-contribution needs to be removed at this time as well (it’s actually counted first), with tax and penalty paid as required.
Second, prior year regular annual contributions to the account. The next money that comes out is the total of all of the money you’ve contributed to the Roth IRA over the years. Of course, this is reduced by all previous distributions from the account. Growth (interest, capital gains, or dividends) on these contributions comes out later.
Third, converted amounts from IRAs or 401(k) accounts would be distributed, along with rollovers from other Roth-type accounts (* but not Roth IRAs, see below). Only the amount of the conversion or rollover is counted at this point and each conversion or rollover is considered on a first-in, first-out basis. As with the contributions, the growth or earnings within the account comes out later. This category is split into two parts, distributed in this order for each conversion or rollover (again, first-in, first-out):
- taxable conversions – the portion of any conversion from a regular IRA or other non-Roth retirement plan
- non-taxable conversions and rollovers – the portion of any conversion or rollover that is not included within your taxable income in the year of the conversion or rollover
Fourth and last, earnings, capital gains, and growth on your contributions, rollovers and conversions will be distributed. This is everything left in the account after the other categories of funds have been removed.
* Rollovers from other Roth IRA accounts maintain their character in the new account as if still a part of the old account – thus, if a rollover from another Roth IRA is made up of partly regular contributions, conversions, and growth, then those amounts are added to the same figures within the new account, and the date(s) of the conversions are added to the mix for first-in, first-out distribution ordering.
With the above note about rollovers from other Roth IRAs in mind, it makes sense that transactions for all Roth IRAs are aggregated and reported as if from one single account. It’s not allowed to only consider one account (of multiple) when determining the distribution ordering.
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Here’s an example: Jane, age 50, has a Roth IRA with a balance of $50,000. She has made annual contributions to the account over the years in the amount of $25,000 – part of which was a contribution this tax year of $5,000. She also made a conversion into this account with $10,000, all taxed, from an IRA a couple of years ago.
When Jane takes money out of the account, she can remove this year’s contribution of $5,000 first of all – no tax on that distribution. After that, the remaining $20,000 of contributions to the account would come out, also tax free. This money is followed by her taxable conversion of $10,000. If it’s been less than five years since the conversion, there will be a 10% penalty on the conversion since she’s under age 59½. Any withdrawal above and beyond $35,000 would represent growth and earnings on the account, which is also subject to the penalty since she’s under age 59½ unless one of the exceptions applies.
