11.2 IRAs, Roth IRAs, and Required Minimum Distributions
Key Takeaways
- Traditional and Roth Individual Retirement Accounts (IRAs) share a single combined annual limit — $7,000 in 2025, plus a $1,000 catch-up at age 50 and older.
- Traditional IRA contributions may be tax-deductible (subject to Modified Adjusted Gross Income, or MAGI, phase-outs if covered by a workplace plan); withdrawals are taxed as ordinary income.
- Roth IRA contributions are after-tax, and qualified distributions are entirely tax-free once the 5-year rule plus a triggering event are met.
- A 10% early-withdrawal penalty applies before age 59 1/2 unless an exception (death, disability, first home, higher education, etc.) applies.
- Required Minimum Distributions (RMDs) from Traditional IRAs begin at age 73; Roth IRAs require no RMDs during the owner's lifetime.
The Two Core IRAs
An Individual Retirement Account (IRA) lets a person with earned income save for retirement with tax advantages, independent of any employer plan. The exam centers on two flavors.
| Feature | Traditional IRA | Roth IRA |
|---|---|---|
| Contribution | Pre-tax (if deductible) | After-tax |
| Growth | Tax-deferred | Tax-free |
| Qualified withdrawal | Taxed as ordinary income | Entirely tax-free |
| Income limit to contribute | None | Yes (MAGI phase-out) |
| RMDs for the owner | Yes, at age 73 | None |
The Shared Limit (2025)
| Category | Amount |
|---|---|
| Base annual limit | $7,000 |
| Catch-up (age 50+) | $1,000 |
| Total (age 50+) | $8,000 |
Critical trap: the $7,000 is a combined ceiling. A 40-year-old who puts $4,000 in a Roth may add only $3,000 more to a Traditional IRA that year — not another full $7,000.
Traditional IRA Deductibility
Whether a Traditional IRA contribution is deductible depends on (1) whether the taxpayer is active in an employer plan and (2) Modified Adjusted Gross Income (MAGI).
- Not covered by a workplace plan: fully deductible at any income.
- Covered by a workplace plan: deduction phases out over a MAGI band (for a single filer in 2025, roughly $79,000-$89,000).
If income is too high to deduct, the person can still make a nondeductible contribution and enjoy tax-deferred growth; that basis comes back tax-free later under a pro-rata calculation.
Memory hook: deductibility is about getting a tax break today; even a nondeductible Traditional IRA still defers tax on earnings.
Roth IRA Qualified Distributions
A Roth withdrawal is qualified (100% tax-free) only when both conditions are satisfied:
- The 5-year rule is met — five tax years have passed since the first contribution to any Roth IRA, and
- A triggering event occurs:
- Owner is age 59 1/2 or older, or
- Death, or
- Disability, or
- First-time home purchase (up to a $10,000 lifetime cap).
If a distribution is non-qualified, ordering rules decide what comes out first:
- Contributions — always tax-free and penalty-free.
- Conversions — tax-free (already taxed), but may face a penalty within five years.
- Earnings — taxable and subject to the 10% penalty if non-qualified.
Worked example: Devin, age 40, contributed $20,000 to a Roth over the years; it has grown to $26,000. He withdraws $15,000. Because contributions come out first, the entire $15,000 is tax-free and penalty-free — he has not yet touched earnings.
Early-Withdrawal Penalty and Its Exceptions
Distributions before age 59 1/2 generally trigger a 10% additional tax on the taxable amount. Exceptions waive the penalty (though not necessarily the income tax):
| Exception | Notes |
|---|---|
| Death | Paid to a beneficiary |
| Disability | Total and permanent |
| First-time home purchase | $10,000 lifetime limit |
| Higher education | Qualified tuition and fees |
| Medical expenses | Above 7.5% of Adjusted Gross Income |
| Health insurance while unemployed | Limited circumstances |
| Substantially equal periodic payments | IRC Section 72(t) |
| Birth or adoption | Up to $5,000 per event |
Worked example: Priya, age 50, withdraws $20,000 of pre-tax Traditional IRA money for a vacation. No exception applies. She owes ordinary income tax plus a $2,000 penalty (10% of $20,000).
Required Minimum Distributions (RMDs)
The government eventually wants its tax on pre-tax money, so Traditional IRA owners must begin Required Minimum Distributions (RMDs) at age 73 (rising to 75 for those born in 1960 or later). The annual amount is:
RMD = (Prior Dec. 31 balance) / (IRS life-expectancy factor)
Worked example: Walter turns 73 with a $500,000 IRA and a life-expectancy factor of 26.5. His RMD is $500,000 / 26.5 = $18,868 (rounded). Missing it formerly cost a 50% excise tax; under current law the penalty is 25%, reduced to 10% if corrected promptly.
| Rule | Detail |
|---|---|
| Traditional IRA start age | 73 |
| Roth IRA (owner) | No lifetime RMD |
| Penalty for a missed RMD | 25% (10% if timely corrected) |
Exam Tip: A Roth IRA owner never has a lifetime RMD — a frequent answer choice. Inherited Roths can still require distributions for the beneficiary.
Carla, age 62, opened her first Roth IRA four years ago. She withdraws $5,000 of earnings. How is this distribution treated?
Walter has a Traditional IRA worth $400,000 as of last December 31 and an IRS life-expectancy factor of 25.0. What is his Required Minimum Distribution for the year?
Traditional vs. Roth at a Glance
| Feature | Traditional IRA | Roth IRA |
|---|---|---|
| Contributions | May be tax-deductible | After-tax (never deductible) |
| Growth | Tax-deferred | Tax-free |
| Qualified distributions | Fully taxable | Tax-free |
| RMDs | Required at the RMD age | None during owner's lifetime |
| Income limit to contribute | None (deduction may phase out) | Yes, contribution phases out at higher income |
The core trade-off: pay tax now (Roth) for tax-free withdrawals, or defer tax until later (Traditional) and deduct now if eligible.
A key advantage of a Roth IRA over a Traditional IRA is that:
RMD Mechanics and the 10% Penalty
For a Traditional IRA, required minimum distributions (RMDs) must begin by the RMD age set in law (currently age 73), with the first payment allowed by April 1 of the year after the trigger year. The annual RMD equals the prior year-end balance divided by an IRS life-expectancy factor. Failing to take an RMD historically triggered a steep excise tax on the shortfall.
The 10% early-distribution penalty applies to withdrawals before age 59 1/2, but exceptions exist: death, disability, qualifying first-home purchase (up to a limit, IRA), higher-education expenses, and substantially equal periodic payments.
Exam Tip: Roth IRAs have no lifetime RMDs; Traditional IRAs do. The 10% penalty is age-based and has named exceptions.