11.2 IRAs, Roth IRAs, and Required Minimum Distributions

The Individual Retirement Account

An Individual Retirement Account (IRA) is a personal, tax-favored savings vehicle that anyone with earned income can open, independent of an employer. The two headline types differ only in when the money is taxed.

The 2025 limits are shared across both account types. A saver may contribute a total of $7,000 ( $8,000 if age 50+), split between Traditional and Roth in any proportion — not $7,000 to each.

Traditional IRA Deductibility

A Traditional IRA contribution is always allowed (with earned income), but the deduction can be limited. The key variable is whether the saver is an active participant in an employer plan.

If the saver is not covered by a workplace plan, the deduction is generally full regardless of income. If covered, deductibility phases out across a Modified Adjusted Gross Income (MAGI) band.

Worked scenario: Marcus, single and covered by a 401(k), has a MAGI of $84,000. He is exactly in the middle of the $79,000–$89,000 band, so roughly half of his contribution is deductible. The non-deductible half still grows tax-deferred and is recovered tax-free later under the pro-rata basis rule.

Roth IRA Eligibility and the 5-Year Rule

Roth contributions use after-tax dollars, so there is no deduction — but qualified withdrawals are entirely tax-free. Eligibility to contribute phases out at higher MAGI (2025: single $150,000–$165,000; married filing jointly $236,000–$246,000).

A Roth distribution is qualified (tax-free and penalty-free) only when both of these are met:

1. The 5-year holding period is satisfied (measured from the first contribution to any Roth IRA), AND
2. A triggering event occurs: age 59 1/2, death, disability, or a first-time home purchase (up to a $10,000 lifetime cap).

If a withdrawal is non-qualified, the ordering rules pull money out in this sequence:

Because contributions come out first, a saver can always reach his own Roth principal tax-free — a common exam point.

Required Minimum Distributions

A Required Minimum Distribution (RMD) is the smallest amount the IRS forces a Traditional IRA owner to withdraw each year so the deferred tax is eventually collected. Under SECURE 2.0, the starting age is 73 (rising to 75 for those born in 1960 or later).

The annual RMD is calculated as:

RMD = Prior 12/31 Account Balance / IRS Life Expectancy Factor

Worked example: Helen, age 73, had a Traditional IRA worth $500,000 on December 31, and her life expectancy factor is 26.5. Her RMD is $500,000 / 26.5 = $18,868 (rounded). She must withdraw at least that amount this year or face an excise tax.

Memory hook: Roth = no RMDs for the owner, which makes the Roth a powerful estate-planning and legacy tool.

Early-Withdrawal Penalty Exceptions

Withdrawals before age 59 1/2 normally trigger a 10% early-distribution penalty on the taxable amount, on top of ordinary income tax. The IRS waives the penalty (not necessarily the income tax) for several life events.

• Death of the owner — beneficiaries take penalty-free.
• Total and permanent disability of the owner.
• Qualified higher-education expenses for the owner or family.
• First-time home purchase, up to a $10,000 lifetime limit.
• Unreimbursed medical expenses above 7.5% of Adjusted Gross Income (AGI).
• Substantially equal periodic payments under IRC Section 72(t).
• Birth or adoption, up to $5,000 per event.

Note the difference: the 10% penalty can be waived, but a Traditional IRA distribution is still taxed as ordinary income unless it represents a return of after-tax basis.

Traditional vs. Roth IRA

A Traditional IRA allows potentially deductible contributions; growth is tax-deferred and distributions are taxable. A Roth IRA uses after-tax contributions, but qualified distributions are entirely tax-free (account held 5 years and owner is 59-1/2, disabled, deceased, or a first-home buyer). Roth contributions (not earnings) can be withdrawn anytime tax- and penalty-free. Both share an annual contribution limit; high earners face Roth income phase-outs. Early distributions of taxable amounts before 59-1/2 incur a 10% penalty plus tax.

Required Minimum Distributions (RMDs)

Traditional IRAs and most employer plans require RMDs beginning at age 73 (under SECURE 2.0). The RMD equals the prior-year-end balance divided by the IRS life-expectancy factor. Missing an RMD triggers an excise penalty (reduced to 25%, or 10% if corrected promptly). Roth IRAs have NO RMDs during the owner's lifetime, a key planning advantage and a frequent exam contrast. Example: a $500,000 balance with a 26.5 factor yields an RMD of about $18,868.