Before we start off with this tutorial its good to digest few terms relevant to

the subject. We have tried to explain each terms briefly for an easy
comprehension.
AGI (adjusted gross income)
Your gross income, which is to say all the money you took in minus certain
"adjustments" such as alimony, moving expenses, deductible retirement plan
contributions, and other deductions.
Contributions
You'd think it would be as simple as 'the money you put into an IRA, otherwise
known as your principal.' But no-o-o-o. The term certainly does include the original
contributions you make to your IRA account. The IRS defines "conversions" to a
Roth IRA as "qualified rollover contributions," and treats these rollover funds as
additional contributions in applicable IRS regulations. However, keep in mind that
the distribution rules are different for "qualified rollover contributions" and regular
contributions.
Distributions, or Withdrawals
Anything taken from your IRA account. In either a traditional or a Roth IRA,
distributions may be comprised of earnings, additional contributions, and/or
conversions. The trick is to see if the distribution is TAXABLE or not, based upon
traditional IRA and Roth IRA rules.
Earnings
The money earned in your IRA as it happily grows from year to year, as distinct from
any contributions that you've made to it.
Annual contribution limits
The amount of money per year you can contribute to your IRA. Annual contributions
to a Roth IRA, for instance, are limited to a maximum annual amount minus the
taxpayer's traditional IRA contributions. The amount you may put into an education
IRA, however, is in addition to the annual limit applicable to traditional and Roth IRA
contributions.
A general definition of hardship withdrawal is a distribution from a 401(k) plan to
be made on account of an immediate and heavy financial need of the
employee, and the amount must be necessary to satisfy the financial need,
according to the IRS. Retirement plans are not required to offer hardship
withdrawals. In context to this you can compare the below situation and
find out the advantage that IRA hardship withdrawals provide.

Employer Plan Hardship Withdrawals

Hardship withdrawals are treated differently depending on whether you have an
employer plan, such as a 401(k) or 403(b), or an IRA. With an employer plan, you
can only take money out of the account before age 59 1/2 if you leave the
company, or have a severe financial burden that you cannot satisfy with other
funds. Even then, the plan must permit hardship distributions and you can still be
required to pay an early withdrawal penalty. Like IRAs, employer plans waive the
penalty in cases of medical expenses exceeding 7.5 percent of your adjusted gross
income and permanent disability. You can also avoid the penalty on an employer
plan hardship withdrawal for a qualified domestic relations order.
IRA Hardship Withdrawals
With an IRA, you can take money out early from your account for any reason
you want. This freedom to remove money at any time is drastically different from
employer plans. However, unless you meet one of the exceptions, you have to pay
an early withdrawal penalty. In addition to the exceptions for certain medical
expenses, IRAs also waive the penalty for college costs and first-time home
buyer expenses (limit $10,000). When you take a hardship withdrawal, you have to
pay a 10 percent penalty on the taxable portion of the distribution on top of your
income taxes, unless you have an exception. If you do have an exception, you still
have to pay the income taxes. However, if you take an early withdrawal from a Roth
IRA, your contributions come out without being taxed. When you take qualified
distributions, you owe no penalties, only any applicable taxes. With tax-deferred
retirement plans, the entire amount is taxable.
Forfeiture
The most common time a forfeiture occurs is when a plan participant terminates
employment and is not 100% vested in the portion of his account attributable to
employer contributions. Forfeitures may also occur due to failed nondiscrimination
testing, participants exceeding statutory deferral limits, or when a participant with a
balance left in the plan cannot be found.
Rollover

A rollover is when you do the following:

1. Reinvest funds from a mature security into a new issue of the same or a similar
security.
2. Transfer the holdings of one retirement plan to another without suffering tax

consequences.

3. Move a forex position to the following delivery date, in which case the rollover
incurs a charge.
In context of TRADITIONAL to ROTH IRA rollovers, It's generally a

good idea for most investors to consider including a Roth IRA in their overall
retirement planning. Roth IRAs have the potential to grow tax-free, which may
help you save more over time. Plus, withdrawals aren't mandatory during the
lifetime of the original owner, and Roth IRA assets may pass to your heirs taxfree.
Rolling a 401(k) directly into a Roth IRA

If you qualify, you can do an eligible rollover distribution from your old 401(k)
directly to a Roth IRA. You'll owe taxes on the amount of pretax assets you roll
over.
Note also, if you have assets in a Designated Roth Account (i.e., Roth 401(k))
and would like to roll these to an IRA, the assets must be rolled into a Roth IRA.
As with Traditional IRA conversions to Roth IRAs, if you are required to take an
MRD in the year you roll over into an IRA, you must take it before rolling over
your assets.
Converting back to a Traditional IRA

Should you wish to convert your Roth IRA back to a Traditional IRA, the process
is known as recharacterization. The deadline to recharacterize Roth IRA
conversion contributions to a Traditional IRA is generally October 15 if you file
your federal income tax return (or file for an extension) on time.
If you have recently recharacterized your account, those assets cannot be
reconverted back to a Roth IRA before the later of:

The beginning of the calendar year following the calendar year of

conversion.

The end of the 30-day period beginning on the day of the

recharacterization.

Consult your tax advisor to determine your eligibility to complete a

recharacterization or a reconversion.

A very important note on perils of converting from Traditional to

Roth IRA :
When you start taking out money, much of it will be taxed. And it will be taxed at your
ordinary income rate, which could be high as 35 percent, rather than the more favorable
rates usually afforded investment income.
That's not the case with a Roth. Once you've held the account for five years, you won't
owe the IRS anything when you withdraw the money at retirement.
Converting a traditional IRA to a Roth gives you that future tax-free benefit, but at
an immediate tax cost. You'll have to pay taxes on contributions that you
previously deducted, as well as on the account's earnings.
Conversion also could push you into a higher tax bracket, especially if you've
accumulated sizable earnings over the years. True, only the portion of your income that
falls into that new bracket will be taxed at the higher rate, but it's still an added bonus for
the IRS at your expense.

You Will Pay Taxes on The Conversion

No matter how the transfer is accomplished, the funds coming out of your traditional IRA
will be subject to regular income tax in the year that it occurs. However, any
nondeductible contributions that you made to your traditional IRA will not be taxable,
since they never had the benefit of tax deferral. If the conversion is done properly, you
will not be subject to a 10% early withdrawal penalty.
If you have begun taking substantially equal periodic payments from your traditional
IRA, you can convert those amounts to your Roth IRA as the payments arrive. The
payments will be taxable, but the 10% early withdrawal penalty will not apply.

Earlier I mentioned RMDs, which are required to be distributed from most other taxsheltered retirement plans. You will not be able convert these distributions to a Roth
IRA.
Roth IRA Conversion Pro-Rata Rule
Some taxpayers mistakenly believe that they can get around the income tax liability
created as a result of making a Roth IRA conversion by rolling over only the portion of
their IRA plans that were made with non-deductible contributions. For example, if a
taxpayer has $200,000 in an IRA account, which includes $100,000 in investment
earnings, $60,000 in tax deductible contributions, and $40,000 in non-deductible
contributions, he may reason that he can avoid creating an income tax liability by rolling
over the $40,000 in non-deductible contributions. It sounds right, doesnt it?
The IRS wont a agree. They have a Roth conversion pro-rata rule, which holds that
the tax exempt portion of your rollover contribution must constitute only a pro-rata share
of the total rollover.
Under this rule, since $40,000 of the taxpayers total IRA balance is comprised of nontax deducible contributions, then he will be eligible for tax relief on only 20% ($40,000 in
non-deductible contributions, divided by the $200,000 total balance) of the amount of
any rollover he converts to a Roth IRA.
Because of the pro-rata rule, if the taxpayer were to convert $40,000 to a Roth, only
$8,000 of it would be exempt from income tax ($40,000 X 20%), not the full $40,000.

Example :
Bentley is over the age of 50 and in the process of changing jobs. Because his
employer had been bought out a few times, he has rolled over previous 401ks into two
different IRAs. One IRA totals $115,000 and the other consists of $225,000. Since hes
never had a Roth IRA, hes considering contributing to a nondeductible IRA for a total of
$6,500 then immediately converting in 2014.

Remember this if you are planning on considering on converting large IRA balances and
have an old 401k. By leaving it in the 401k, it will minimize your tax burden.
Using the steps from above, lets see what Bentleys taxable consequence will be in
2014:
Step 1: $6,500/ $346,000 = 1.88% (pro-rata basis i.e. proportional)
Step 2: 1.88 X $6,500 = $122

Step 3: $6,500 $122 = $6,378

For 2014, Bentley will have a taxable income of $6,378 of his $6,500 Traditional IRA
contribution/Roth IRA conversion, and thats assuming no investment earnings. As you
can see, you have to be careful when initiating conversion.

Qualified distribution (for Roth IRA)

A withdrawal(qualified one) from a Roth IRA that is :

After you get disabled

A

Made to beneficiary after you die

59
1/2

used to pay for qualified

1st time homebuyer

Made after you attain a certain age

Roth IRA is an IRA authorized on or after January 1, 1998, in which

1.

Contributions to the account are not deductible.

2.

"Qualified" distributions (i.e., withdrawals) from the account are not taxable.

3.

Earnings on the account are taxable only when a withdrawal is not a

"qualified" distribution.

Traditional, or Regular, IRA

An individual retirement account that may have both deductible and non-deductible
contributions, and in which earnings accrue tax-deferred, but will be taxed as
ordinary income on withdrawal.

Now, let us delve deep into various topics related to traditional and Roth IRA
starting with what is actually an IRA ?

An Individual Retirement Arrangement (IRA), commonly called an Individual

Retirement Account, is a personal retirement savings plan available to anyone
who receives taxable compensation during the year. For IRA contribution
purposes, compensation includes wages, salaries, fees, tips, bonuses,
commissions, taxable alimony, and separate maintenance payments.

Traditional IRAs
The tax breaks for a traditional IRA are of the "this is tax-deductible" kind. That
means that, depending on previously discussed factors, the money you deposit in
your IRA isn't taxed. And regardless, whatever earnings you have on your
contributions won't be taxed until you withdraw that money many years later.

Income :
$30,000

Trad IRA
contb. :
$2,000

In hand :
$28,000

Not
taxed

Taxed

For example, let's say you made $30,000 during the year, and you put $2,000 of it
into an IRA. You would pay income tax on only $28,000. Additionally, your deposit
will grow free of tax through the years. When you finally withdraw the money for your
retirement -- after age 59 1/2 -- then, and only then, will the money be taxed as
income at your ordinary income tax rate.
If you withdraw the funds before age 59 1/2, then in most cases you'll have to
pay both income tax and a 10% penalty on whatever earnings have accrued
-- but if the funds are used to pay for "qualified higher education expenses" or for

one of the other eight exceptions(listed below for reference) to the 10% early
withdrawal penalty, then the penalty will be waived :1.

Occur because of the IRA owner's disability.

2.

Occur because of the IRA owner's death.

3.

Are a series of "substantially equal periodic payments" made over the life
expectancy of the IRA owner.

4.

Are used to pay for unreimbursed medical expenses that exceed 7 1/2% of
adjusted gross income (AGI).

5.

Are used to pay medical insurance premiums after the IRA owner has
received unemployment compensation for more than 12 weeks.

6.

Are used to pay the costs of a first-time home purchase (subject to a

lifetime limit of $10,000).

7.

Are used to pay for the qualified expenses of higher education for the IRA
owner and/or eligible family members.

8.

Are used to pay back taxes because of an Internal Revenue Service levy
placed against the IRA.

The Roth IRA

The tax breaks for a Roth IRA are different. Unlike a contribution to a traditional
IRA, a Roth IRA contribution is never tax-deductible. Taking the above example,
you'd still be taxed on $30,000 even though you had put the same $2,000 into a
Roth IRA. However, when you withdraw the money from a Roth IRA, none of it
-- and that includes the earnings -- will be taxed, assuming that the Roth IRA
has been open for at least five tax-years and you are older than age 59 1/2.
That's right -- you get off scot-free with the booty. All you have to do is to wait until
you can withdraw it penalty-free. Again, that's after age 59 1/2, and as long as it's
been in there for at least five years.

Roth IRA
contb. :
$2,000

Taxed

Income :
$30,000

Taxed

In hand :
$28,000

In other words, the Roth offers tax- exemption rather than simply taxdeferred savings. One word makes a big difference. While both allow you to
accumulate wealth without paying taxes along the way on your profits, the traditional
IRA ultimately sticks you with a tax bill for those profits (plus your initial contributions
if those were deducted when made). The Roth doesn't. As long as you follow the
rules, you never pay taxes on your gains. So paying the piper now before
contributing to the Roth may work out to be better for you than paying him later on
your investment profits.
The Roth makes particular sense for people otherwise limited to making nondeductible contributions to a regular IRA. And the Roth is fully available to single
filers making up to $95,000 and couples making up to $150,000. It also allows you
great flexibility by allowing you, in many cases, to withdraw your principal
contributions at any time tax-free, without penalty. First-time homebuyers can also
pull out $10,000 in profits penalty free and tax-free if the money has been in the
Roth IRA for at least five tax years. There are also some breaks for education
spending, though an Education IRA may be a better vehicle for education savings.
Barring these exceptions, though, profits withdrawn before retirement age and
before the money has been in the Roth for at least five tax-years will be taxed, plus
you'll also incur a 10% penalty when those earnings are taken before age 59 1/2.

Decision of whether To Convert or Not to Convert

Because the Roth is potentially better than the traditional IRA, it may make sense for
you to convert a current traditional IRA into a Roth. To do so, you will have to pay
taxes on your old IRA, but there will be no penalty for early withdrawal. Is this a
smart thing to do? The answer depends on your income tax rate today versus that in
retirement; how you will pay the income tax bill due on the conversion; how long the
Roth IRA will remain untouched; and the size of the IRA coupled with your desires
for your estate. For a discussion of some of the considerations involved in making
such a decision, see "Convert to a Roth IRA."
In general, if you have to use your IRA savings to pay taxes triggered by shifting
them to a Roth, then you may be sacrificing too much principal up-front to make the
deal worthwhile, unless you have many years to make up for this dip into your
savings. You should also note that funds rolled over into a Roth IRA come under
greater restrictions for penalty-free and tax-free distributions as compared to normal
Roth IRA contributions.
So, if we could understand the above mentioned concepts it will be a good idea to
traverse through three main components namely contribution, conversion and
distribution (i.e. withdrawal ) of ROTH IRA to have a concrete insight-about the nittygritties of the topic.
1st - > Details of contribution
An individual may make an annual nondeductible contribution to a Roth IRA that
may not exceed the smaller of the maximum allowable annual IRA contribution or
100% of the individual's earned income for that year, minus the total of all
contributions for that tax-year to all other individual retirement plans (other than
Education IRAs) owned by that person.
What this means is that your total contributions for the tax-year to a traditional IRA
and a Roth IRA may not exceed the total contribution allowed for that year. So now
its time to decide on which savings vehicle youll contribute. . While the law certainly
doesn't prohibit you from placing, for example, $500 in a Roth IRA and $1,500 in a
traditional IRA, the administrative hassles and fees of this type of arrangement are
not negligible. But because of the Roth IRA phase-out rules (that we'll discuss

below), "splitting" your allowable IRA contribution into a traditional IRA and a Roth
IRA may be your only option if you want to make a full contribution for that year.
A couple of distinctions to note:
1. Be aware that you may contribute to a Roth IRA and a SEP, SIMPLE, and/or
Education IRA at the same time. The annual contribution limit on IRAs is only
applicable to the combination of traditional and Roth IRAs. So if you are in a
situation where you are able to fully fund a Roth IRA and a SEP, SIMPLE,
and/or Education IRA, the law allows you to do so.
2. Remember also that you may contribute to a Roth IRA even if you are covered
by a company retirement (pension/401(k)/profit sharing) plan.

Example
John is a single taxpayer. In 2001 he will make $50,000 in earned income. John is
also a participant in his company's pension plan. Additionally, John will contribute the
maximum amount to his employer's 401(k) plan. In his spare time, John has a
consulting job and will earn additional business (Schedule C) income in the amount
of $15,000. John will make a maximum SEP IRA contribution based upon his net
business income. John also makes an Education IRA contribution for the benefit of
his daughter. Even with all of these tax-deferred savings and investment vehicles,
John can still make a $2,000 Roth IRA contribution for 2001.
It should also be noted that any amounts converted to a Roth IRA (which we'll
discuss next) in a "qualified rollover contribution" are not counted toward the
maximum annual contribution limit. So in the example above, even with everything
John had going on, he could make a "qualified rollover contribution" and still have
the choice of making a $2,000 Roth IRA contribution for 2001.

Income Limitations
And now for the bad news -- some individuals may not be eligible for the Roth
IRA. Limitations based on your tax filing status and adjusted gross income (AGI) are
listed below:
$95,000

$10,000

Single and Head of Household Filers

Income: AGI = $95,000 or less.

Rule: The maximum annual contribution to a Roth IRA is allowable (assuming

Full Roth
Partial
Roth
that the earned compensation rules are met).
contributi
Roth
contributi
on
contributi
on NOT
When AGI rises above $110,000, no Roth IRA contribution
Between
allowed is allowable.
on
allowedthe

$95,000 and $110,000 phase-out range, only a partial Roth IRA contribution will be
allowed.
Joint Filers

Income: AGI = $150,000 or less.

Rule: The maximum annual contribution to a Roth IRA for each of the joint
filers is fully allowable (again, assuming that the earned compensation rules
are met).

When AGI rises above $160,000, no Roth IRA contribution is allowable. Between the
$150,000 and $160,000 phase-out range, only a partial Roth IRA contribution will be
allowed.

$150,000

Full Roth
contributi
on
allowed

$160,000

Partial
Roth
contributi
on

Roth
contributi
on NOT
allowed

Married Filing Separately

For married persons filing separate returns, the AGI limitation is so severe as to
virtually prohibit a Roth IRA contribution. For married/separate filers, the "phase-out"
range is between $0 and $10,000. This means that a married/separate filer will

never be able to take a full Roth IRA contribution, and when AGI rises above
$10,000, no Roth IRA contribution will be allowed whatsoever.
So whats up with a Phase-Out Range?
If you fall into the phase-out ranges listed above, your Roth IRA contribution is
limited on a pro-rata basis (i.e. proportional), depending on how far your AGI
moves into the phase-out range. Get an idea on this from the below example.
Example

Jill -- a single person -- has an AGI of $105,000, has earned income of at least $2,000, and is not
a participant in her employer's pension/profit sharing plan. Since Jill is two-thirds into the phaseout range, she is only allowed a one-third contribution to her Roth IRA. Therefore, her maximum
Roth IRA contribution for 2001 would amount to $666.67 (which she can round up to $670).
Since her Roth IRA was limited, can she make a traditional IRA contribution? Sure... in the
amount of $1,330. Will that IRA contribution be deductible? That will depend on Jill's
circumstances. In our example, Jill isn't a participant in her employer's pension/profit sharing
plan, so her traditional IRA would be fully deductible. If she were a participant in her employer's
pension plan, her deductible IRA contribution would have been limited.
You should be aware that there are no age limits on contributions to a Roth IRA. A
young child with earned income can make a Roth IRA contribution if it is deemed
appropriate. Also, unlike a regular IRA, persons over the age of 70 1/2 can still make
Roth IRA contributions as long as they have earned income and are not otherwise
restricted by the AGI limitations. And, unlike a regular IRA, a Roth IRA is not
subject to the "required minimum distribution" or MRD (as we know) rules that
require minimum IRA distributions when you turn age 70 1/2.
Remember that Roth IRA contributions for a tax-year must be made no later than the
due date of your tax return, not including extensions. So if you are qualified to make a
2001 Roth IRA contribution, that contribution must be made no later than April 15, 2002,
the due date of your tax return.

2nd Details of Conversion

For many people, the Roth IRA is clearly the better choice over a regular IRA. However,
what if you already have a traditional IRA? Can you wave your magic wand and turn it
into a Roth? Perhaps... it depends on whether your wand meets certain conditions.
Conversion must be qualified
The term "qualified rollover" can get a little complex, but it is basically a rollover that
meets the 60-day rollover time period, and is not in violation of the "one-year" rollover
rules. For additional information regarding qualified rollovers, see IRS Publication 590,
"Individual Retirement Arrangements."
Adjusted gross income limitations
Assuming you can get over the "qualified" distribution rules, you still have one other
hurdle to clear -- the adjusted gross income (AGI) limitations. The law states that if your
AGI is greater than $100,000, you may not convert from a traditional IRA to a Roth IRA.
This $100,000 limitation applies not only to single filers, but also to married people filing
jointly and head-of-household filers. Furthermore, don't think you can beat the AGI
limitations by filing a married-separate tax return. You can't. The law specifically states
that if you are a married taxpayer filing a separate tax return, you may not convert your
traditional IRA to a Roth IRA, regardless of your AGI.
(Note: What if you made a Roth conversion last January and now find that your AGI will
exceed the $100,000 limitation? First, don't panic. You have the ability to "recharacterize" your Roth IRA back to a traditional IRA without penalty if you follow a few
simple steps.)
And remember that the AGI limitations are computed without regard to the amount of
the conversion.
Example
Jack, a single person, has an AGI of $75,000. Jack also has a traditional IRA in the
amount of $60,000 that he wants to convert to a Roth IRA. For AGI limitation purposes,
Jack's conversion threshold is $75,000 (the amount of his "normal" AGI, without regard
to the conversion amount), and not the total of his "normal" AGI and his "conversion"
amount. Jack's AGI for income tax purposes will change if he decides to make this
conversion, but that's an issue that we'll discuss in detail a little later.

Conversion Taxation Issues

OK, you've decided that you can make a Roth conversion. Now you need to know more
about the tax issues involved in making the conversion.
In effect, the funds converted from the traditional IRA to the Roth IRA that would have
been taxable had the distribution not been part of a qualified conversion will be subject
to income tax at your normal tax rate. If your IRA consists only of prior deductible
contributions and the earnings thereon, the total amount of the conversion will be
subject to taxation.
If part of your IRA consists of prior nondeductible contributions, they will not be taxed
again at the time of the conversion.
And if your IRA consists of funds from a prior rollover from another qualified pension
plan (such as a pension/profit sharing plan, 401(k) plan, 403(b) plan, Keogh plan, SEP
plan, etc.), all of the funds will be taxable to you at the time of the conversion.
No penalty
Because the conversion is "qualified," the 10% penalty for an early withdrawal from an
IRA account will not be imposed. In effect, the conversion can be made without paying
the 10% IRA early withdrawal penalty. But should you decide to remove these converted
funds "early" from the Roth IRA, you may be subject to a penalty. Early withdrawal
penalty issues are discussed here.
Confused? No need. Let's continue with the example of Jack and his conversion.
Example
Jack's AGI is $75,000, and he made a $60,000 conversion from his regular IRA to a
Roth IRA this year. Now Jack's AGI for income tax purposes will be $135,000 (his
regular AGI of $75,000 plus all of his conversion income of $60,000).
Jack will not be hit with a 10% early withdrawal penalty on the amount of the IRA
converted to the Roth IRA (assuming Jack keeps his nose clean and doesn't take the
funds out of his Roth IRA "early").

Finally, as noted above, all of the tax issues that use AGI for a benchmark (except Roth
contributions and conversions) will now be based on Jack's new AGI of $135,000 for
this tax year. So, his medical threshold is 7.5% of $135,000. His miscellaneous itemized
deduction threshold is 2% of $135,000.
Jack decided to pay more tax dollars to Uncle Sammy right now. In effect, Jack is
trading tax dollars now for the tax-free status of the Roth earnings in the future. Is that
appropriate? Perhaps for Jack, based on his personal situation, the answer is yes. But it
is not necessarily appropriate for everyone. In fact, for some people, converting a
regular IRA to a Roth IRA might actually cost them additional tax dollars in the long run.
That is why the Roth IRA conversion debate has become very heated. The decision to
make this conversion is very personal, based on personal status, goals, age, intentions,
etc. Therefore, the "to convert or not" question can only be answered by you, based on
your personal financial, estate, and tax situation.

3rd Details of Qualified distributions

We've now reviewed the provisions in the law regarding the Roth IRA contribution
(putting your cash in) and eligibility rules (the stick). Here we'll review the tax treatment
of qualified distributions (getting your cash out) from the Roth IRA (the carrot).
Qualified Distributions
Any qualified distribution from a Roth IRA is NOT included in gross income for individual
tax purposes. Simple as that. In effect, a qualified distribution from a Roth IRA is taxfree... no taxes due on the principal... no taxes due on the earnings... no taxes due,
period.
To be qualified, the distribution MUST be:
1. Made on or after the date you become age 59 1/2; OR
2. Made to your beneficiary, or to your estate, after you die; OR
3. Made to you after you become disabled within the definition of the IRS code; OR
4. Used to pay for qualified first-time homebuyer expenses.

But -- and this is a very big but -- even if one of the qualifications above is met, the
distribution is STILL not qualified if it is made within a five-tax-year period. We'll see how
to compute the five-tax-year holding period a bit later. Just know that five tax-years are
NOT necessarily the same as five calendar years.
So, in effect, there are two sets of rules that must be met before a Roth IRA distribution
becomes qualified, and therefore tax-free: The distribution rules and the five-tax-year
rules. Unless both sets of rules are met, the distribution will NOT be qualified, and the
earnings will be subject to tax, and possibly penalties. We'll discuss penalties in detail in
the next article.
Example #1
Bill, who is 25, makes a Roth IRA contribution of $2,000 this year. Seven years later
(well beyond the five-tax-year period), Bill closes his Roth IRA and takes a distribution in
the total amount of $4,500 (representing the original $2,000 contribution and $2,500 in
earnings). Bill is not disabled, nor does he use these funds to pay first-time homebuyer
expenses. Since Bill is NOT over age 59 1/2 when he takes the distribution, the
distribution is NOT qualified. Bill will owe income taxes on the $2,500 of earnings.
Additionally, Bill will be assessed a 10% early withdrawal penalty on this $2,500 of
earnings unless he meets one of the other six authorized exceptions for avoiding that
penalty. Ouch.
Remember that, under the Roth IRA rules and unlike the rules for a regular IRA, you
can first remove your contributions without tax or penalty. So, in Example #1 above, if
Bill decided to take a withdrawal of only $2,000, it would be treated as a distribution of
his original contributions, and would not be subject to taxes or penalties. That only
makes sense since Bill didn't get to deduct that contribution from his taxable income
when it was originally made (so, he's already paid income tax on the money).
The lesson ? Don't get too creative here. The IRS has ordering rules that must be
followed whenever you take a distribution from a Roth IRA..
Furthermore, Roth IRAs containing both conversions and regular contributions fall under
a slightly different set of rules. It's still possible to remove your contributions (tax- and
penalty-free), but the rules can get a bit more complex. For now, let's move on to the
five-tax-year rule.

The Five-Tax-Year Rule

Let's take a few minutes to discuss the five-tax-year rule. The waiting period for a
qualified distribution may be shorter than five calendar years, especially if a contribution
is made after the close of the tax year for which it is recognized. Remember that you
have until April 15 of the following year to make a contribution for the current tax year.
And, according to the law, the first year that is counted is the year for which the
contribution is made, not the calendar year in which the contribution is actually made. In
effect, the very earliest date that a "normal" (i.e., no special issues such as death or
disability) qualified Roth IRA distribution could possibly be made would be Jan. 1, 2003
because you were not able to contribute to a Roth IRA prior to Jan. 1, 1998.
Example #2
Mike, at age 57, made a $2,000 contribution to his Roth IRA on April 15, 1999 for tax
year 1998. On Jan. 2, 2003, Mike withdraws $3,000 from his Roth IRA when he is over
age 59 1/2. Of the $3,000 withdrawn, $2,000 represents the original contribution, and
$1,000 represents the earnings.
This entire distribution is qualified, and is not included in Mike's taxable income because
it was made after the five-tax-year period expired, and Mike was over age 59 1/2 when
he took the distribution. For purposes of the five-tax-year rule in this example, 1998
counted as the first tax-year, so the five-tax-year period expired at the end of 2002.
Even though Mike had his funds in his Roth IRA for less than five calendar years, he
has met the five tax-year rules, and his distribution is qualified.
Once the five-tax-year holding period is met, any distribution from the Roth IRA will be
excludable as a qualified distribution if it is made after age 59 1/2 or if it meets one of
the other requirements for a qualified distribution. Keep in mind that each conversion
from a traditional IRA will have its own individual five tax-year holding period. This might
be one very good reason to keep your conversions and contributions segregated in
separate Roth IRA accounts. However, with respect to annual contributions only, the
first contribution or conversion begins the five-tax-year clock ticking. Still not clear?
Then let's take a look at Frank.
Example #3

Frank, age 58, converts a $2,000 traditional IRA to a Roth IRA on April 15, 1999.
Therefore, his five-tax-year clock started ticking in 1999.
In August of 2000, he makes a $2,000 annual contribution for tax-year 2000. In January
2001, he makes his $2,000 contribution for 2001. In February 2003, he makes a $4,000
contribution ($2,000 each for tax years 2002 and 2003). In January 2004, when Frank is
62 years old, the value of his Roth IRA account is $15,000 ($8,000 in contributions and
$7,000 of earnings). Frank takes a distribution of the entire balance of his Roth IRA
account.
Is Frank's $15,000 distribution tax- and penalty-free? You bet your bippy! The entire
amount is a qualified distribution, and no part of the distribution will be subject to tax or
penalty. Why? Because, at the time of the distribution, Frank was over age 59-1/2 and
the five-tax-year period for his original conversion was met.
Frank's five-tax-year clock began ticking in 1999 (the tax year in which he made his first
contribution through the conversion of his traditional IRA), and it expired on Dec. 31,
2003. Since his distribution took place after Dec. 31, 2003, his entire distribution is
qualified and not subject to taxes or penalties. All of the transactions that took place in
his Roth IRA account after the initial conversion contribution were meaningless for the
five-tax-year holding rules.
Finally, you might be under the mistaken impression that Roth IRA contributions and
conversions must be maintained in completely separate Roth IRA accounts. No longer
true. The changes to the Roth IRA rules in the Tax Reform Act of 1998 made the need
for these "separate" accounts moot. It's now acceptable to "co-mingle" your Roth IRA
conversions and contributions, since the same five-tax-year rules apply to both. So, if
your broker still insists that you segregate your conversion funds and contribution funds,
tell him (or her) of the new law that removed the segregation restrictions.
But remember that there are still different five-year holding periods for conversions and
contributions. Don't get lulled into thinking that, as long as your contribution holding
period has been met, your conversion holding period has also been met. The five-taxyear holding period for conversions begins in the tax-year each conversion is made.
****************************************************************************

On an additional note let us cover up some points on early withdrawal.

Early withdrawal
Now that we have discussed contributions, conversions, and qualified distributions, we
will now look at the distribution ordering rules and penalties on "early" withdrawals from
a Roth IRA.
IRS Ordering Rules
The IRS does not care from which Roth IRA you take a withdrawal. If you have multiple
IRAs, they are considered as one Roth IRA for withdrawal purposes. Further, the IRS
has deemed that Roth IRA distributions MUST be withdrawn in a specific order, and that
order applies regardless of which Roth IRA is used to take that distribution. Roth
distributions should be made in the following order:
1. From non-taxable annual contributions to a Roth IRA (other than conversion
amounts)
2. From conversion contributions, on a first-in, first-out (FIFO) basis
3. From earnings
Who cares? You might -- especially if you find that you have to take an early withdrawal.
Let's look at some examples.
Penalties on Earnings from Contributions
Unless an exception applies, most distributions from a Roth IRA before the owner
reaches age 59 1/2 will be subject to an "early withdrawal penalty" of 10% on the
amount of the distribution. Be very careful NOT to confuse the early withdrawal penalty
with the taxes imposed on a non-qualified distribution (discussed in Part III). A nonqualified distribution imposes an ordinary income tax on the distribution, but the early
withdrawal penalty will be imposed in addition to that tax.
Example #1
Jim, age 30, made a Roth IRA contribution of $2,000 in 1998. In 2005, Jim's Roth IRA
has a balance of $3,500. Jim decides to close his Roth IRA in a non-qualified
distribution that year. Since the distribution is non-qualified, Jim will owe taxes on his

Roth earnings of $1,500, and will pay tax on this amount at his marginal tax rate. In
addition, since the distribution took place before Jim reached age 59 1/2, and since Jim
did not meet any of the exceptions, Jim will also be assessed a 10% early withdrawal
penalty on the earnings. If we assume that Jim is in the 28% marginal tax bracket, he
will pay $420 in tax on the earnings, and will pay a penalty in the amount of $150 on the
early distribution. This is a very steep price to pay.
Exceptions
The early withdrawal penalty does not apply to distributions that:
1. Occur because of the IRA owner's disability. (This can be a very narrow
definition, so if you get a severe paper cut, don't consider a Roth IRA distribution
for a disability until you review IRS Code Section 72(m)(7) and IRS Publication
590.)
2. Occur because of the IRA owner's death.
3. Are a series of "substantially equal periodic payments" made over the life
expectancy of the IRA owner.
4. Are used to pay for unreimbursed medical expenses that exceed 7 1/2% of
adjusted gross income (AGI).
5. Are used to pay medical insurance premiums after the IRA owner has received
unemployment compensation for more than 12 weeks.
6. Are used to pay the costs of a first-time home purchase (subject to a lifetime limit
of $10,000).
7. Are used to pay for the qualified expenses of higher education for the IRA owner
and/or eligible family members.
8. Are used to pay back taxes because of an Internal Revenue Service levy placed
against the IRA.
Penalties on Conversions From a Traditional IRA to a Roth IRA
The penalty rules regarding conversions are a bit different than those for annual
contributions, which may be taken at any time for any purpose free of income taxes and

penalty. An early withdrawal of a conversion contribution has a different twist. The early
withdrawal penalty applies to a distribution of conversion money from a Roth IRA when:
1. The distribution is made within the five-tax-year period starting with the year that
the conversion was distributed from a regular IRA; and
2. Only to the extent that the distribution is attributable to amounts that were
includable in gross income as a result of the conversion.
Example #2
Paul made a $20,000 conversion from his regular IRA to a Roth IRA in 1998. The entire
amount converted was includable in Paul's income for 1998. Paul made no additional
contributions or conversions to a Roth IRA in 1998 or in later years. In 2001, before he
is age 59 1/2, Paul withdraws $10,000 from the Roth IRA. Paul will have no tax to pay
on this withdrawal because he paid income taxes on the full $20,000 he converted in
1998; however, he WILL have to pay a 10% penalty (or $1,000) unless one of the IRA
early withdrawal exceptions apply. Why? Because Paul didn't keep the conversion
amount in his Roth IRA for the required five-tax-year period since his original
conversion.
So, if you are going to take funds "early" from your Roth IRA, weigh your conversion
decision very carefully -- especially if you made non-deductible contributions to your
original IRA. If you did make non-deductible contributions to your regular IRA, you'll
generally be worse off by converting to a Roth IRA and taking the funds early than you
would be by simply taking the funds from the regular IRA.
Why? Because a pro rata part of all withdrawals from a regular IRA are treated as
coming out of non-deductible contributions. But, amounts withdrawn from Roth IRA
conversions are treated as coming out of income taken into account on the conversion
first.
Not quite clear on how this works? Let's take a look at an example:
Example #3
Karin has a traditional IRA with a balance of $12,000 -- $6,000 of that IRA balance was
from prior-year deductible contributions and total IRA earnings. The other $6,000
represents prior-year non-deductible contributions. Karin is contemplating a Roth IRA

conversion, but also wants to take a distribution of $4,000. Karin's options are as
follows:
1. She can leave her money in the traditional IRA and take the $4,000 distribution.
She'll be taxed on half of the distribution ($2,000) because half of the account is
deductible contributions and earnings. She'll also pay a 10% penalty, but only on
the $2,000 taxable distribution. The other $2,000 is tax- and penalty-free since it
came from prior non-deductible contributions to the IRA.
2. She can convert the entire traditional IRA to a Roth IRA and then take the $4,000
distribution. This is a bad choice for Karin. Once Karin takes the $4,000
distribution, she'll be subject to a 10% penalty on the entire distribution, or $400,
because of the ordering rules. She won't have to pay any tax on the distribution
(since the tax was paid when she converted the traditional IRA to the Roth IRA),
but making this choice causes Karin to pay an additional $200 in penalties that
could have been avoided with proper planning.
On the other hand, if you are reasonably young (under age 50) and expect to need to
withdraw funds from your IRA in five years (and can't use any exceptions to avoid the
10% penalty), you might be better off converting funds from your regular IRA to a Roth
IRA now. If you wait until after the five-tax-year period to withdraw money from a Roth
IRA, the 10% penalty won't be imposed, even if you aren't yet 59 1/2 and don't meet any
other exception to the penalty.
Why? Because, for a Roth IRA, you have met the five tax-year exception on the
converted funds and therefore dodge the 10% penalty on these distributions. But, there
is no five-tax-year exception for a traditional IRA. So, while you would still pay tax on
the earnings in either case, you would escape the 10% penalty by converting to a Roth
IRA.
Still not clear on this? Another example might be in order.
Example #4
Rick converted $15,000 from his traditional IRA to a Roth IRA in 1999, and another
$20,000 from a second traditional IRA in 2003. These conversions were all taxable to
Rick when they occurred because he had made no non-deductible contributions to his

traditional IRAs. He has no other Roth IRAs and he has not made any additional
contributions to this Roth IRA since the original conversions.
In 2006, when Rick is still under age 59 1/2, he takes a distribution of $15,000. Is this
distribution subject to tax? Nope, since the taxes were paid on these funds at the time of
the conversion from the traditional IRA to the Roth IRA. Is this distribution subject to the
10% penalty? Nope again, because Rick held the conversion funds in the Roth IRA
account for longer than the required five-tax-year period.
But what if Rick took a distribution of $20,000 in 2007? In that case, he would still
receive $15,000 of that distribution tax- and penalty-free because it has been more than
five tax-years since his first conversion of $15,000. But the second IRA was converted
less than five tax-years ago. Therefore, the remaining $5,000 of his $20,000 distribution
will be penalized 10% for an early withdrawal because he has not yet met the five-taxyear rule to tap into the second conversion contribution of $20,000. And when he takes
that sum, he will have only $15,000 of conversion money left before he begins to take
earnings from that Roth IRA.
As you can see, the tax-planning implications on Roth IRA withdrawals are numerous -too numerous to mention here. Different tax and penalty rules can apply to distributions
coming from contributions, conversions, or earnings.
Not only that, the rules regarding the 10% penalty on "early" (less than five tax-years)
distributions relative to conversion amounts are determined for each conversion, and
might not necessarily be the same five-tax-year period that you use to determine if a
distribution is "qualified" for income tax purposes.
And, the penalty rules are different for conversions than they are for earnings from
contributions. It can be a real mess.
If your Roth IRA consists of only contributions or only conversions, these rules aren't too
difficult to follow. But if your Roth IRA consists of contributions, conversions in different
years, and earnings on both, then the "qualified" distribution rules and the penalty rules
can get very complex.

So, you really need to know the tax impact of your decision prior to removing any of
your Roth IRA funds -- you can't just guess. Guessing could be hazardous to your
wealth.
Your best bet? Keep your paws off your Roth IRA account unless your distribution is
qualified and you meet one of the penalty exceptions. It'll make your tax life much
easier.
ADDITIONAL GLOSSARY :
Traditional Interest Payment Retirement Option (IPRO)
This option provides monthly payments drawn only from the current interest credited to
your TIAA Traditional accumulation in the Basic Plan. Since only the interest is paid to
you, your accumulation remains untouched. This option is available to those who are
age 55 to 69 and have terminated employment, retired, or employees on phased
retirement (Phased Retirement is a human resources tool that allows full-time employees to
work part-time schedules while beginning to draw retirement benefits.). After 69, you can
choose it only if you are on phased retirement and plan to continue working for at least
another year. In general, you must convert from the interest-only option to a lifetime
annuity, a fixed-period annuity, or to the Minimum Distribution Option by April 1 following
the year you turn 70 if you are no longer working or following the year you retire
or terminate, whichever is later.
SWAT(systematic withdrawal and transfer)
It is a facility to plan for your retirement and other regular monthly income needs
through the Systematic Withdrawal Plan (SWP). Depending on your needs for monthly
or quarterly income, you can then choose to withdraw either a fixed sum per month or
quarter, or the capital appreciation in the Net Asset Value of your investment.
You create a systematic withdrawal plan by providing us with the following instructions
for a fund account:
Amount of each withdrawal
Withdrawal frequency (monthly or quarterly)
A date for the first withdrawal
Delivery instructions for the money

 Each withdrawal will be processed automatically according to the details of your

plan.
Let us see the analysis of a SWAT calculator to get a nice overview :

Savings & Assumptions

Current savings balance
Proposed monthly withdrawal amounts
Annual withdrawal increases (if any):
(%)
Annual before-tax return on savings:
(%)
Federal marginal tax bracket: (%)
Desired amortization schedule

Your money will last approximately 6.0 years with systematic withdrawals totaling to $4,850.

Month
1
2
3
4
5
6
7
8

Beginning Balance
4000
3,970
3,939
3,908
3,877
3,844
3,811
3,778

Annual Interest @ 8%
27
26
26
26
26
26
25
25

Taxes @ 25%
7
7
7
7
6
6
6
6

Withdrawals
-50
-50
-51
-51
-52
-52
-53
-53

Ending Balance
3970
3,939
3,908
3,877
3,844
3,811
3,778
3,744

..
67
68
69
70
71
72

467
383
298
211
124
35

3
3
2
1
1
0

1
1
0
0
0
0

-86
-87
-88
-89
-89
-35

383
298
211
124
35
0

RMD (Required minimum distribution) and RRMD (Recurring required

minimum distribution)
Once you reach age 70, the IRS requires you to take money out of your
retirement
accounts. These mandatory withdrawals are called required minimum
distributions
(RMDs). 1

Were here to help.

S

You must take an RMD for:

Individual Retirement Accounts (IRAs)
Traditional
Rollover
Inherited
Simplified Employee Pension (SEP)
Savings Incentive Match Plan for Employees
(SIMPLE)
Qualified Retirement Plans1 (QRPs)
Individual 401(k)
403(b)
You do not need to take RMDs for Roth IRAs unless you have inherited one.
Roth 401(k) accounts are also subject to RMD rules.

Understand the timing.

Your first RMD must be taken no later than April 1 of the year following the
calendar year in which you turn age 70. Subsequent RMDs must be taken
by December 31 of each year. If you wait until April 1 of the year after you
turn age 70 to take your first RMD, you will have to take two distributions
in the same year: one for the year you turn age 70 and one for the current
year. This could have additional tax implications.

Example:

If you:

You must:

Turn age 70
this year

Take your first RMD by

April 1 of next year.

Turned age 70
years RMD
last year

Ensure you take your first RMD by April this year. And, take this

Turned age 70 in
A previous year

before December 31.

Continue taking your RMD before December 31 each year.

You may be liable for a 50% penalty on insufficient or late RMD withdrawals.
However, there is no RMD for Roth IRAs.

Choose how to get your distribution.

You have several ways to get your distribution. You can:
Receive your IRA distribution online.
Set up recurring RMDs(RRMD) .Your annual RMD will be
automatically calculated and then transferred to the account you
designate.
Transfer investments in kind, such as move stocks, mutual funds, or cash
from your IRA into your nonretirement account.
Request a check.