11.2 IRAs, Roth IRAs, and Required Minimum Distributions
Key Takeaways
- A Traditional Individual Retirement Account (IRA) offers potentially deductible contributions and tax-deferred growth; distributions are fully taxed as ordinary income.
- A Roth IRA uses after-tax contributions, so qualified distributions of both principal and earnings are completely tax-free.
- The 2025 IRA contribution limit is $7,000, plus a $1,000 catch-up for those age 50 and older.
- Premature distributions before age 59 1/2 generally trigger a 10% IRS penalty plus ordinary income tax on Traditional IRAs.
- Required Minimum Distributions (RMDs) from Traditional IRAs must begin by April 1 following the year the owner turns 73; Roth IRAs have no RMDs during the owner's lifetime.
An Individual Retirement Account (IRA) is a personal, tax-advantaged retirement account that any individual with earned income (compensation from work) can open, even without an employer plan. The exam centers on two types: the Traditional IRA and the Roth IRA.
Traditional vs. Roth at a Glance
| Feature | Traditional IRA | Roth IRA |
|---|---|---|
| Contributions | May be tax-deductible | Always after-tax (never deductible) |
| Growth | Tax-deferred | Tax-deferred |
| Qualified distributions | Fully taxable as ordinary income | Completely tax-free |
| Required Minimum Distributions | Yes, beginning at age 73 | None during owner's lifetime |
| Income limit to contribute | None | Phased out at higher incomes |
The core trade-off: a Traditional IRA gives a tax break now and taxes you later; a Roth IRA takes the tax now and lets qualified money out tax-free later.
Contribution Limits and Earned Income
For 2025, the annual contribution limit is $7,000, with an additional $1,000 catch-up contribution for individuals age 50 and older (a $8,000 total).
Key rules:
- Contributions require earned income (wages, self-employment). Investment income, Social Security, and rental income do not count.
- A spousal IRA lets a non-working spouse contribute based on the working spouse's compensation, on a joint return.
- Contributions above the limit incur a 6% excise tax each year the excess remains.
Worked example: Devin is 52 and earns $90,000. His maximum 2025 IRA contribution is $7,000 + $1,000 catch-up = $8,000. If he mistakenly contributes $9,000, the $1,000 excess is taxed at 6% = $60 per year until corrected.
Premature Distributions and Penalties
Money taken from a Traditional IRA before age 59 1/2 is generally subject to a 10% IRS penalty on top of ordinary income tax.
Common penalty exceptions (10% waived, but Traditional withdrawals are still taxable):
- Death or total disability of the owner
- Qualified first-time home purchase (up to $10,000 lifetime)
- Qualified higher-education expenses
- Substantially equal periodic payments
- Certain unreimbursed medical expenses
Exam trap: The exceptions waive only the 10% penalty, not the income tax on a Traditional IRA. A Roth IRA's contributions (basis) can always be withdrawn tax- and penalty-free; only the earnings are subject to penalty if withdrawn early and non-qualified.
Roth Qualified Distributions
A Roth distribution is qualified (entirely tax-free, including earnings) only if both conditions are met:
- The account has been open for at least 5 years (the 5-year rule), AND
- The owner is age 59 1/2 or older (or death, disability, or first-home purchase up to $10,000).
Because contributions were already taxed, the IRS treats withdrawals as contributions first, earnings last, which protects early withdrawals of principal from tax.
Required Minimum Distributions (RMDs)
The IRS will not let Traditional IRA money grow tax-deferred forever. Required Minimum Distributions (RMDs) must begin by April 1 of the year following the year the owner reaches age 73 (the "Required Beginning Date"). After the first year, each subsequent RMD is due by December 31.
RMD calculation: Divide the prior year-end account balance by the IRS life-expectancy factor.
| Account balance (Dec 31 prior year) | Life-expectancy factor (age 73) | RMD |
|---|---|---|
| $500,000 | 26.5 | $18,868 |
| $250,000 | 26.5 | $9,434 |
If the owner fails to take the full RMD, the shortfall is hit with a 25% excise tax (reduced to 10% if corrected promptly).
Roth note: Roth IRAs have no lifetime RMDs for the original owner — a major planning advantage tested on the exam.
A 73-year-old retiree has a Traditional IRA worth $500,000 as of December 31 of the prior year. Using an IRS life-expectancy factor of 26.5, what is the approximate Required Minimum Distribution, and what penalty applies if the entire RMD is skipped?
Which IRA feature is unique to a Roth IRA?
Worked Numeric: RMD Calculation and the SECURE Act Rules
Required minimum distributions (RMDs) must begin from traditional IRAs and most employer plans by April 1 of the year after turning 73 (SECURE 2.0). Roth IRAs have no RMDs during the owner's lifetime.
Worked RMD: an account worth $500,000 with an IRS life-expectancy factor of 25.0 requires a distribution of $500,000 / 25.0 = $20,000 that year. Missing an RMD historically triggered a steep excise tax (reduced to 25%, or 10% if corrected promptly under SECURE 2.0).
Also know the inherited-IRA 10-year rule: most non-spouse beneficiaries must empty an inherited IRA within 10 years. And the early-withdrawal penalty: distributions before 59 1/2 generally incur a 10% penalty on top of ordinary income tax, unless an exception applies (death, disability, first-home up to $10,000, qualified education, substantially equal periodic payments).