11.2 IRAs, Roth IRAs, and Required Minimum Distributions
Key Takeaways
- IRAs require earned income; traditional contributions may be deductible (income-tested if covered by an employer plan), while Roth contributions are never deductible.
- Roth qualified distributions are entirely tax-free after 5 years and age 59½, and contributions can be pulled out anytime tax- and penalty-free.
- A 10% early-withdrawal penalty applies before 59½ unless an exception (death, disability, first-home, education, medical) applies.
- Traditional IRA RMDs begin at age 73 by the required beginning date; Roth IRAs have no lifetime RMDs for the owner.
- RMD = prior year-end balance ÷ life-expectancy factor; missing it triggers a 25% excise tax (10% if promptly corrected).
Individual Retirement Arrangements
An Individual Retirement Arrangement (IRA) is a personally owned, tax-advantaged retirement account that any individual with earned income (wages, salary, self-employment income) may open. Investment, alimony, and pension income do not count as earned income for funding purposes. IRAs are not employer plans, but they interact with employer-plan coverage for deduction purposes.
Traditional IRA mechanics
- Contributions may be tax-deductible, subject to income limits if the owner (or spouse) is an active participant in an employer plan.
- Growth is tax-deferred.
- Distributions are taxed as ordinary income to the extent they represent deductible contributions and earnings.
- A 10% premature-distribution penalty applies to withdrawals before age 59½, on top of ordinary income tax, unless an exception applies (death, disability, first-home up to $10,000, qualified higher-education, certain medical costs).
- Required Minimum Distributions (RMDs) must begin (see below).
Roth IRA mechanics
A Roth IRA flips the tax treatment:
- Contributions are never deductible (always after-tax).
- Growth is tax-deferred.
- Qualified distributions are entirely tax-free — both principal and earnings — if the account has been open 5 years and the owner is 59½, disabled, deceased, or making a first-home purchase.
- Contributions (basis) can be withdrawn any time tax- and penalty-free; only earnings withdrawn early are taxable and may incur the 10% penalty.
- A Roth owner is not subject to RMDs during their lifetime — a key contrast with the traditional IRA.
Traditional vs. Roth at a glance
| Feature | Traditional IRA | Roth IRA |
|---|---|---|
| Contribution deductible? | Sometimes (income-tested) | Never |
| Growth | Tax-deferred | Tax-deferred |
| Qualified distribution | Taxed as ordinary income | Tax-free |
| Early-withdrawal penalty | 10% before 59½ | 10% on earnings before 59½ |
| Lifetime RMDs for owner | Yes | No |
| Income limit to contribute | No (deduction limited) | Yes (phase-out) |
Anchor: "Traditional = deduct now, pay later; Roth = pay now, withdraw free."
Contribution rules common to both
- A single annual dollar limit applies across all of an individual's IRAs combined (traditional + Roth) — not per account.
- A catch-up contribution is allowed for those age 50 and older.
- Contributions for a tax year may be made up to the tax-filing deadline (generally April 15 of the following year), with no extensions.
- A nonworking spouse may use a spousal IRA based on the working spouse's earned income on a joint return.
- Excess contributions are penalized 6% per year until corrected.
Required Minimum Distributions (RMDs)
The SECURE Act changes raised the traditional-IRA RMD beginning age to 73. The owner must take the first RMD by April 1 of the year after turning 73 (the required beginning date), then by December 31 each year thereafter.
The penalty for failing to take a full RMD is a 25% excise tax on the shortfall (reduced to 10% if corrected promptly). Roth IRAs have no lifetime RMDs. Inherited accounts generally follow a 10-year drawdown rule for most non-spouse beneficiaries.
Worked RMD calculation
Miguel turns 73 this year. On the prior December 31 his traditional IRA balance was $500,000 and the IRS Uniform Lifetime Table factor for age 73 is 26.5.
RMD = account balance ÷ life-expectancy factor = $500,000 ÷ 26.5 ≈ $18,868.
If Miguel withdraws only $10,000, he is short $8,868. The excise tax could be 25% × $8,868 ≈ $2,217 (or 10% ≈ $887 if corrected promptly). Memorize the divide-the-balance-by-the-factor method — that is the tested mechanic.
Olivia, age 45, withdraws $20,000 from her Roth IRA, of which $15,000 represents her original contributions and $5,000 is earnings. The account is 7 years old. What is the tax result?
A traditional IRA owner's December 31 balance was $400,000 and the applicable life-expectancy factor is 25.0. What is the required minimum distribution?
Conversions, the pro-rata rule, and rollovers into IRAs
Beyond annual contributions, the exam tests how money moves into and between IRAs.
- A Roth conversion moves traditional-IRA dollars into a Roth IRA. The converted amount is taxable as ordinary income in the conversion year, but there is no 10% penalty on the conversion itself and no income limit on converting. Future qualified Roth withdrawals are then tax-free.
- The pro-rata rule prevents cherry-picking only after-tax dollars: if a traditional IRA holds both deductible and nondeductible (after-tax) contributions, every distribution or conversion is treated as a proportional mix of taxable and nontaxable money. Nondeductible basis is tracked on IRS Form 8606.
- Rollovers from a qualified plan into an IRA preserve tax deferral. A direct (trustee-to-trustee) rollover avoids the 20% mandatory withholding that applies to indirect rollovers paid to the participant.
- The once-per-12-months limit applies to indirect IRA-to-IRA rollovers (one across all IRAs), but trustee-to-trustee transfers and Roth conversions are unlimited.
Worked conversion example
Dana converts a $60,000 traditional IRA to a Roth. The entire IRA was funded with deductible contributions and earnings (no after-tax basis), so the full $60,000 is added to taxable income this year. At a 24% marginal rate the conversion tax is about $14,400. Once five tax years pass and Dana is 59½, all Roth withdrawals — principal and growth — come out tax-free.
An individual completes a $60,000 traditional-to-Roth IRA conversion. The traditional IRA contained only deductible contributions and earnings. What is the immediate tax consequence?
Spousal versus non-spouse inherited IRA rules
Inherited IRAs follow different drawdown rules the exam tests. A surviving spouse may treat the inherited IRA as their own (rolling it over and using their own RMD schedule) or remain a beneficiary. Most non-spouse beneficiaries must empty the account under the 10-year rule following the SECURE Act, with no annual stretch over their lifetime. Certain eligible designated beneficiaries (minor children of the owner, disabled or chronically ill individuals) may still stretch distributions. Roth IRAs avoid lifetime RMDs for the owner but inherited Roths are still subject to the 10-year rule.