2024 IRA Versus Roth Distributions Rules:

Are you looking to make informed decisions about your retirement savings for 2024? If so, understanding the rules and guidelines for IRA and Roth distributions is crucial. In this blog post, we will explore the key differences between these two retirement options and delve into the specific regulations for the year 2024. From making contributions to receiving distributions, we’ll break down the important details you need to know. By the end of this article, we hope you’ll have a clearer understanding of how IRA and Roth accounts can impact your financial future. So, let’s dive in and explore the 2024 IRA versus Roth distributions rules together.

Making Contributions:

• To contribute to an IRA or Roth IRA, you need earned income. For 2024, the maximum contribution is $7,000 for under age 50 and $8,000 for age 50 and older.
• An IRA is deductible when there is no employer qualified plan available. Therefore, there is no Adjusted Gross Income (AGI) limitation that applies.
• If you have an employer plan, the AGI phaseout for a contribution to be deductible for a Single taxpayer is $77,000 to $87,000; $123,000 to $143,000 for Married Filing Jointly; and $0 to $10,000 for Married Filing Separately.
• If you have an employer plan and your spouse does not, the AGI phaseout for deductibility for the spouse is $230,000 to $240,000 for Married Filing Jointly and $0 to $10,000 for Married Filing Separately.
• If you are unable to deduct the IRA contribution, you can always contribute to a non-deductible IRA.
• If you want to contribute to a Roth IRA instead using after-tax contributions, the AGI phaseouts are $138,000 to $153,000 for a Single taxpayer; $230,000 to $240,000 for Married Filing Jointly; and $0 to $10,000 for Married Filing Separately.

Receiving Distributions:

• A distribution from an IRA with no after-tax contributions will be fully taxed as ordinary income.
• When an IRA has both pre-tax and post-tax contributions, the calculation of the tax-free portion of the distribution is made using the following formula: (After-tax Contributions / FMV of all IRA Accounts Before Distribution) x Distribution = Tax-free Return of Basis. For example, if you made $14,000 of after-tax IRA contributions and take a $10,000 distribution when the FMV before the distribution from your IRA when the value is $100,000, the tax-free portion is ($14,000 / $100,000) x $10,000 = $1,400 and the remaining $8,600 is taxed as ordinary income (subject to a 10% penalty if distributed before age 59-1/2). The new adjusted basis for additional distributions is $14,000 – $1,400 or $12,600.
• However, a Roth IRA uses the following ordering rule to determine any taxable portion of a distribution using the First-In-First-Out(FIFO) Method. A distribution from the Roth IRA distributes contributions first, any Roth conversions second, and finally any earnings on the account. Therefore, if $14,000 was contributed to a Roth IRA when the value is $100,000 and you take a $10,000 distribution, the amount is return of contributions and is tax-free return of basis. The adjusted basis is $14,000 – $10,000 or $4,000. However, if the distribution is $20,000, the first $14,000 is return of basis and the remaining $6,000 is earnings. To determine if this is taxable or not, you need to follow the rules below.

The Roth 5-Year Rule:

• The 5-year rule for a Roth IRA means that at least 5 years must elapse between the beginning of the tax year of your first contribution to a Roth account and withdrawal of earnings. If fewer than 5 years have passed and withdrawal of earnings is made, the withdrawal is considered a nonqualified distribution and may be subject to either ordinary income or a 10% early withdrawal penalty (or both). For example, if $5,000 was contributed on April 4, 2024 as a 2023 tax year Roth contribution (you have until the April 15^th filing deadline of the tax return to make a prior year contribution), the contribution is deem made on January 1, 2023 and the 5-year period is satisfied on December 31, 2027.
• Once the 5-year rule has been met and the account owner is 59½ or older, a qualified distribution of earnings is exempt from both income taxes and the 10% early withdrawal penalty.
• The 5-year rule applies to all Roth IRAs, even if the account holder is 59½ or older. A withdrawal made from the originally owned Roth IRA and an inherited Roth IRA received by a beneficiary will use the first contribution made by the original owner regarding the 5-year rule. However, when a Roth conversion is made, there is a separate 5-year aging rule that covers each separate conversion from a traditional IRA to a Roth IRA to consider.

Roth Conversions and Other Applicable 5-year Rules:

• Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
• The Internal Revenue Service (IRS) requires a waiting period of 5 years before withdrawing balances converted from qualified funds to a Roth IRA. If this requirement is not met, a 10% early withdrawal penalty and ordinary income on the conversion amount that represents earnings with an exception to the penalty for withdrawals if you are age 59½ or older.
• Regardless of what day in the calendar year that a Roth conversion is made, the date of conversion is deemed made on January 1 of the year. So if a Roth conversion occurs in December, the 5-year holding requirement is a little more than 4 years.
• Each Roth conversion will have their own 5-year holding period to account for.
• The 5-year holding period also applies to inherited Roth IRAs. Even if the account holder is older than age 59½.
• Like inherited traditional IRAs, beneficiaries of Roth IRAs must take yearly RMDs based on the owner’s age. Assuming the 5-year aging rule is met, distributions will be tax-free. Withdrawal of earnings may be subject to income tax if the 5-year rule is not met. However, the 10% early withdrawal penalty will not apply due to receiving on death exception.
• Required Minimum Distributions (RMD) apply to an IRA but not to a Roth IRA owner. However, when the owner passes, both the IRA and Roth IRA have RMD requirements for a non-spouse beneficiary who will be required to distribute the entire account by the tenth year after the passing of the owner.

As you can see from the above information, there are many rules and planning opportunities to consider. Please contact us if you have any questions.