Ordering Rules for Roth IRA Distributions

Tax (Photo credit: 401K)

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 account.

Ordering rules

First, over-contributions or return of your annual contribution for the tax year.  This means that if you’ve made a contribution to the Roth IRA in the tax year, the first money that you withdraw from the account will be the money that you contributed that year.  If you over-contributed to your account a prior year. Growth on this over-contribution or annual contribution needs to be removed at this time as well, with tax and penalty paid as required.

Second, 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.  This amount would include rolled over contribution amounts from other Roth IRA or Roth 401(k) accounts. Growth (interest, capital gains, or dividends) on these contributions comes out later.

Third, tax-free converted amounts from IRAs or 401(k) accounts would be distributed.  Only the amount of the conversion is counted at this point.  As with the contributions, the growth or earnings within the account comes out last.

Fourth, conversion amounts that were taxed at the time of the conversion are distributed.

Fifth and last, earnings, capital gains, and growth on your contributions will be distributed.  This is everything left in the account after the other categories of funds have been removed.

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 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 would also be subject to the penalty since she’s under age 59½.