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1 posts from March 2016

03/02/2016

Roth IRA vs. Traditional IRA:Distribution Advantage

Roth IRAs have a specific advantage vs. Traditional IRAs when it comes to distributions.

For a Traditional IRA all distributions are deemed to consist of both contributions and earnings. This makes the entire distribution taxable becasue the contributions where made with pretax money.

Roth IRA potential distribution advantages over a Traditional IRA are based off of the order of distributions. There are three types of distributions that occur with Roth IRAs:

1) Return of Contributions: Principle is returned first, and there is no income tax or 10% penalty assessed on this portion.

2) Return of Conversion Amount: If there was a conversion of Traditional IRA money to a Roth IRA this money will not be subject to income tax, since it was taxed when converted. If the individual is under age 59 1/2 it will be subject to the 10% early withdrawal penalty if the funds have not been in the Roth IRA for at least 5 years from date of conversion.

3) Return of Earnings: Earnings come out last. They will not be taxed if it is a qualified distribution. Qualified Distribution is a distribution of money for an individual attaining 59 1/2 and the five year holding requirement has been met. If it is not a qualified distribution, then it will be subject to income tax and the 10% early withdrawal penalty for individuals under 59 1/2 years old.

Being able to distribute contributions first and avoid taxation is a big advantage of Roth IRAs.