section 1 - The American College Online Learning Center

a. Tax-exempt plans include Roth IRAs and Roth accounts in a 401(k), 403(b)or 457(b) planb. Qualifying distributions are always tax-free.c. Nonqualifying withdrawals are taxed differently depending upon whether thewithdrawal is from a Roth IRA or Roth account.10. Qualifying Roth Distributions which are tax exempt must satisfy both the 5-year and thetrigger event rulesa. The five-year rule requires that the distribution occurs after the 5-year tax periodbeginning with the first tax year for which a contribution was made andb. A triggering event includes(1) Attainment of age 59½(2) Death or disability of the participant(3) Up to $10,000 of qualified first-time homebuyer expensesc. The 5-year rule applies differently depending upon whether the plan is a Roth IRAor Roth account11. Nonqualifying withdrawals12. Examples:(1) Roth IRAs—the 5-year period begins for all Roth IRAs based on theestablishment of the first Roth IRA(2) Roth 401(k) accounts—each plan must meet 5-year rule; however, whena distribution is rolled into a Roth IRA, the 5-year period starts over andthe favorable Roth IRA taxing rule now applies.a. Roth IRAs receive favorable tax treatment.(1) Contributions are considered withdrawn first and are not taxed.(2) Once contributions have been withdrawn, additional distributions ofearnings are taxed as ordinary income and possibly the 10% earlywithdrawal penalty.b. Roth accounts do not have the same favorable tax treatment.(1) Withdrawals are subject to a pro-rated recovery rule, so a portion of eachdistribution is treated in part as a return of contributions and a part istreated as earnings.(2) This unfortunate tax issue can be easily resolved by rolling the distributionfirst to a Roth IRA and then taking the distribution from the Roth IRA.a. Facts: Alex, currently age 55, set up a Roth IRA in 2003. The current value is$40,000. Alex contributed $22,000 and has taken no distributions.b. Question: What happens if he withdraws $15,000?c. Answer: This is a nonqualifying withdrawal—but there are no income taxconsequences as this is considered a return of contributions.d. Question: What if he withdraws all $40,000 to pay his son’s college educationexpenses?e. Answer: This is still a nonqualifying withdrawal—and $18,000 of earnings will besubject to income tax and the 10% early withdrawal penalty; however there will beno 10% penalty as the college education exception applies to this fact-pattern.13. The Roth tax checklist. The general rule is that distributions which qualify are tax-exempt.However, ask these questions:4.10