By Sarah Brenner, JD
Director of Retirement Education
Question:
I have a question about the Roth IRA distribution ordering rules based on a client’s situation:
1. The client is 45 years old.
2. She has had a Roth IRA open for five plus years.
3. She made a $6,000 contribution to a Roth IRA when she originally opened it.
4. We transferred a Roth 401(k) balance of $10,000 to her Roth IRA in October 2023, with a basis of $9,000 according to the statement from the 401(k) provider.
The client needs to take a distribution from her Roth IRA, and I want to ensure it’s done in the most tax-efficient way possible. I understand that the original contribution of $6,000 will come out without tax or penalty. However, I’m unsure if the Roth 401(k) contribution will also come out without tax or penalty. Are these dollars considered contributions to a Roth IRA, subject to the contribution rules, or do they fall under a different category of contributions requiring a five-year holding period?
Thank you for your assistance.
Matthew
Answer:
Hi Matthew,
The rule for determining taxation of Roth IRA distributions after rollovers from Roth 401(k) plans can be very complicated.
The Roth ordering rules apply. Any contributions come out first and earnings come out last. These rules are applied across the board to include any Roth IRAs that an individual might have. In your client’s situation, I am assuming that there is only one Roth IRA.
The $6,000 Roth IRA contribution will come out tax and penalty-free. Also, the $9,000 in “basis” from the Roth 401(k) plan can also be distributed tax and penalty-free. That would mean that up to $15,000 could be distributed without tax or penalty.
Any earnings in the Roth IRA (including the $1,000 that originated in the plan) would come out last. A distribution of earnings would be taxable and subject to the 10% early distribution penalty. That’s because, even though the Roth five-year holding period is satisfied, the individual is only age 45 (i.e., under 59 ½).
Question:
Are you able to aggregate a self-directed IRA with other traditional IRAs (and withdraw from one traditional IRA) for required minimum distribution (RMD) purposes?
Best,
Adam
Answer:
Hi Adam,
Yes. You are permitted to aggregate RMDs from traditional IRAs (including SEP and SIMPLE IRAs). There is nothing that restricts aggregation of RMDs for self-directed IRAs. In fact, aggregation is often used to satisfy RMD requirements for self-directed IRAs when there are liquidity concerns.