In a blog post from June 8, One Roth IRA Bucket, I created a scenario where a person had five Roth IRAs, a couple of traditional IRAs, and was doing Roth conversions. The point of that exercise was to demonstrate how the IRS knows what dollars within all of a person’s Roth IRAs are contributions, conversions, and earnings. Additionally, I stressed that the IRS treats the entirety of a person’s Roth IRAs as a single Roth IRA. A fundamental understanding of distribution ordering rules is essential for Roth IRA owners.
It is essential to know which dollars are which, within a Roth IRA because Roth IRA distributions follow strict ordering rules. There is no such thing as FIFO (“first in, first out”) with a Roth IRA. LIFO (“last in, first out”) and pro rata also have zero bearing on Roth IRA withdrawals.
There is a simple ordering procedure for Roth IRA distributions:
- Contributions come out first. When they are depleted;
- Converted dollars come next. When they are depleted;
- Earnings come out last.
That’s it. Those are the ordering rules. It does not matter from which Roth IRA you take a distribution. Remember, all the IRS sees when it looks at your accounts is one bucket of Roth IRA dollars, subdivided into contributions, conversions, and earnings.
What about access to these dollars?
A person can always withdraw Roth IRA funds, no questions asked. The issue is whether those dollars will be subject to the 10% early withdrawal penalty and/or taxes. This article will not get into the weeds of the Roth 5-year clocks, nor will it cover exceptions to the 10% penalty. Space is limited. However, below is an overview of the different types of Roth IRA dollars and a brief explanation of when those funds are available.
Contributions.
Roth IRA contributions are always available tax and penalty-free. If you contributed to a Roth IRA in any year, you can withdraw those dollars at any time for any reason. Fortunately, based on the ordering rules, Roth IRA contributions come out first. Converted dollars and earnings will stay put until you exceed the number of contributions with your withdrawals.
Conversions.
Conversions come out next. Since you paid for taxes upfront, these dollars come out tax-free. Roth IRA converted dollars are penalty-free after five years OR age 59 ½. The word “or” is critical. If you meet one of the parameters, the converted dollars are available. There are no other variables. Did you hit your 5-year conversion clock on these specific converted dollars? OR are you 59 ½ or older? If yes, you have full access to the converted Roth IRA funds.
Earnings come out last.
Earnings are available tax and penalty-free after five years AND 59 ½. The word “and” is crucial. BOTH must be satisfied. (Note that earnings are always penalty-free if you are over 59 ½.) If you had any Roth IRA for five years, AND you meet the age limit, congratulations! All your Roth IRA dollars will forever be tax and penalty-free.
By Andy Ives, CFP®, AIF®
IRA Analyst
