11.2 IRAs, Roth IRAs, and Required Minimum Distributions
Key Takeaways
- IRAs require earned income; Traditional and Roth share one combined annual limit ($7,000, plus $1,000 catch-up at 50+).
- Traditional IRA deductibility depends on active-participant status and MAGI phase-outs; nondeductible contributions still create tax-free basis.
- Roth contributions are after-tax; qualified distributions are tax-free when the 5-year rule and a triggering event (age 59½, death, disability, first home) are met.
- Pre-59½ distributions face a 10% penalty plus tax, subject to exceptions like death, disability, first home, and education.
- Traditional IRAs require RMDs at age 73 (balance / life-expectancy factor); Roth IRAs have no lifetime RMDs.
Individual Retirement Accounts
An Individual Retirement Account (IRA) lets a person with earned income save for retirement with tax advantages, independent of any employer plan. The exam focuses on three flavors: Traditional, Roth, and the question of deductibility and distributions.
The core dividing line: a Traditional IRA may give a deduction now and taxes you later; a Roth IRA gives no deduction now but distributions later can be entirely tax-free.
Contribution Limits (current)
Both Traditional and Roth share a single combined annual limit. Contributing to both does not double it.
| Category | Limit |
|---|---|
| Annual contribution (under 50) | $7,000 |
| Age 50+ catch-up | $1,000 |
| Combined total (age 50+) | $8,000 |
A contribution requires earned income (wages or self-employment) at least equal to the amount contributed. A spousal IRA lets a non-working spouse contribute based on the working spouse's income on a joint return.
Trap: Excess contributions above the limit incur a 6% excise tax each year until withdrawn.
Traditional IRA Deductibility
Whether a Traditional IRA contribution is deductible depends on whether the taxpayer (or spouse) is an active participant in an employer plan and on Modified Adjusted Gross Income (MAGI).
| Situation | Deduction Result |
|---|---|
| Not covered by any employer plan | Fully deductible at any income |
| Covered, MAGI below phase-out | Fully deductible |
| Covered, MAGI in phase-out range | Partial deduction |
| Covered, MAGI above phase-out | No deduction (nondeductible contribution allowed) |
Even when no deduction is allowed, a nondeductible contribution still grows tax-deferred and creates basis that returns tax-free pro-rata at distribution.
Roth IRA Mechanics
Roth contributions are after-tax, so they never reduce current income. Eligibility itself phases out at higher MAGI (high earners may use a backdoor conversion instead).
A qualified distribution is tax-free and penalty-free when both conditions are met:
- The account has satisfied the 5-year rule (5 tax years since the first Roth contribution), and
- The owner is age 59½, disabled, deceased, or uses up to $10,000 for a first home.
Key advantage: a Roth owner faces no required minimum distributions during life, making it a powerful estate and tax-diversification tool.
Early Distributions and the 10% Penalty
Distributions before age 59½ generally trigger a 10% early-withdrawal penalty plus ordinary income tax on the taxable portion. Common penalty exceptions tested on the exam:
| Exception | Notes |
|---|---|
| Death or total disability | No penalty |
| First-home purchase | Up to $10,000 lifetime |
| Qualified higher education | Tuition, fees, books |
| Substantially equal periodic payments | Series of equal payments |
| Medical expenses / health insurance | Above an AGI threshold; certain unemployed |
Worked example: A 45-year-old withdraws $20,000 from a fully deductible Traditional IRA for a vacation. Tax = ordinary income on $20,000 plus a 10% penalty of $2,000. None of the exceptions apply.
Required Minimum Distributions (RMDs)
To prevent indefinite deferral, Traditional IRAs (and most employer plans) require withdrawals beginning at age 73 under SECURE 2.0. The first RMD may be delayed to April 1 of the year after the owner turns 73; every later RMD is due by December 31.
RMD formula: RMD = prior-year-end balance / IRS life-expectancy factor.
| Step | Example |
|---|---|
| Dec 31 balance | $500,000 |
| Life-expectancy factor (≈ age 73) | 26.5 |
| RMD = 500,000 / 26.5 | ≈ $18,868 |
Trap: Missing an RMD triggers a steep excise tax (25%, reduced to 10% if corrected promptly) on the shortfall. Roth IRAs have no lifetime RMDs.
Rollovers and Conversions
IRA money can move without immediate tax through a rollover or transfer. A trustee-to-trustee transfer moves funds directly between custodians with no limit on frequency. An indirect (60-day) rollover pays the owner, who must redeposit within 60 days; only one indirect IRA rollover is allowed per 12 months across all IRAs.
A Roth conversion moves Traditional IRA dollars into a Roth. The converted pre-tax amount is taxable as ordinary income in the conversion year, but no 10% penalty applies to the conversion itself. After conversion, future qualified growth comes out tax-free, which is why high earners use the strategy to escape Traditional RMDs.
Inherited IRAs and Beneficiary Rules
Beneficiaries do not simply keep the account untouched. A spouse may treat an inherited IRA as their own, deferring distributions and naming new beneficiaries. Most non-spouse beneficiaries must instead empty the account under the 10-year rule — the entire balance must be distributed by the end of the 10th year after death.
Worked comparison: A surviving spouse inheriting a $300,000 IRA can roll it into her own IRA and delay RMDs until age 73. An adult child inheriting the same $300,000 must fully drain it within 10 years, accelerating the taxable income.
A taxpayer has a Dec 31 Traditional IRA balance of $400,000 and an IRS life-expectancy factor of 25.0 for the year. What is the required minimum distribution?
Which feature is unique to a Roth IRA compared with a Traditional IRA?