The ROTH IRA is possibly one of the best tools ever created for Americans.
We love the ROTH IRA. We love it for a variety of reasons. It is a great way to save funds today and not worry about taxation in the future. We also love the ROTH IRA for divorce litigants who only have retirement funds, and they need more money to fund their divorce or to take care of post-divorce needs like buying a new home or extra cash for expenses when the divorce is over.
The only issue to the ROTH IRA is – there are rules. The IRS does not make this easy! This article is a guideline to help you understand the ROTH IRA in general as well as the various rules associated with the ROTH IRA. We are hoping this helps you understand the best sources for cash if you need it during or after your divorce. With that said, this article gets pretty deep on the rules. If you want clarification feel free to contact us. We will gladly answer your financial related questions.
ROTH IRA Basics
- You may only contribute to a Roth IRA if you make less than a certain amount of money: $135,000 for single filers and $199,000 for married couples filing jointly. (These figures are up from $133,000 and $196,000 for 2017.)
- The maximum annual direct contribution to a Roth IRA is $5,500 unless you are age 50 or over, in which case it is $6,500.
- You may make a contribution anytime from January 1 to the tax filing deadline (April 15 in 2019).
- This can be a good place to take assets from in the gamut of retirement assets for divorce purposes. You can request the contributions (tax basis) of the ROTH IRA be distributed to you only and that amount will be tax free and penalty free.
- The ROTH IRA is typically a more desirable asset to receive from your spouse in divorce than a Traditional IRA, SIMPLE IRA, SEP IRA or 401k due to taxation today and taxation in the future.
ROTH IRA Distribution Rules Overview
- If you are 59½ or over, you may withdraw as much as you want, as long as your Roth IRA has been open for at least 5 years.
- If you are under 59½, you may withdraw the exact amount of your Roth IRA contributions with no penalties.
- There are special exemptions for first-time home purchase and college expenses.
- You can receive the ROTH IRA from your spouse pursuant to divorce without taxation or penalty and the tax basis will transfer with the asset.
- You must ask your attorney to find out how much of the ROTH IRA is basis and if you are only taking a portion of the ROTH IRA, you need to specify what the basis is and how much each of you are keeping.
ROTH IRA Distribution Rules in Detail
No doubt, Roth IRAs are a good deal for U.S. retirement savers, but don’t go in blind to a Roth IRA withdrawal situation. There are several key rules and distinctions you should know before taking out any funds. Otherwise, you may be tagged with a 10% early withdrawal penalty.
Here are five Roth IRA withdrawal rules you should know, no matter what (as always, consult with a trusted financial advisor before making any big decisions about an IRA withdrawal):
1) Distribution of Your Basis or Contributions
Tax free in /tax free out. An investor can take out the exact amount of his or her Roth IRA contributions at any time, for any reason without having to pay any tax or penalty. You must specify when you call the firm that you only want your contributions distributed.
Special note: when getting a divorce, if you receive the ROTH IRA be sure to find out how much of that ROTH IRA is a contribution. You need this information to take out some of the funds tax free. The information will likely NOT be automatically offered, you must ask or have your attorney mandate the information.
2) Roth IRA Five-Year Rule
Withdrawals from your Roth IRA will only be classified as qualified distributions if it has been at least five years since you first opened and contributed to your Roth IRA, regardless of your age when you opened it. For instance, an IRA owner can make penalty-free withdrawals at age 59½, but if he or she made the first contribution at age 58, the plan participant would need to wait until age 63 to withdraw any earnings made on that portion of the original contributions.
3) Qualified Versus Non-Qualified Distributions
Before making any Roth IRA plan withdrawals, know the difference between “qualified” and “non-qualified” distributions.
A qualified distribution from a Roth IRA is tax-free and penalty-free, provided that the five-year aging requirement has been satisfied and one of the following conditions is met:
- Over age 59½
- Death or disability
- Qualified first-time home purchase
Non-qualified distributions are subject to taxation of earnings and a 10% additional tax unless an exception applies.
Several exceptions exist that enable Roth IRA plan participants to withdraw cash from Roth IRAs that otherwise would be subjected to ordinary income taxes and the 10% early withdrawal penalty:
- The distributions are part of a series of substantially equal payments (minimum five years or until the Roth IRA owner reaches age 59½, whichever is longer).
- You have unreimbursed medical expenses exceeding 10% of your Adjusted Gross Income (AGI). [Note that under the new tax law, the medical-deductions threshold is scheduled to be 7.5% for 2017 and 2018 and revert to 10% after that.]
- You are paying medical insurance premiums after losing your job.
- The distributions are not more than your qualified higher education expenses (for yourself or eligible family members).
- The distribution is due to an IRS levy of the qualified plan.
- The distribution is a qualified reservist distribution.
- The distribution is a qualified disaster recovery assistance distribution.
- The distribution is a qualified recovery assistance distribution.
[Visit https://www.irs.gov/forms-pubs/about-publication-590b for more information on Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).]
4) First Home Purchase Exception
There are other loopholes that enable you to take money out of a Roth IRA without fear of incurring a tax penalty. One is for a first home purchase, up to a $10,000 lifetime maximum amount, per individual IRA account. According to IRS rules, first home purchase assets can be withdrawn for the account holder, or for the account holder’s children or grandchildren.
5) College Expenses Exception
Uncle Sam also allows penalty-free withdrawals from a Roth IRA for assets earmarked toward college expenses for the account holder, or for the account holder’s spouse, children and grandchildren (great-grandchildren, too).
This is a good asset to have for children’s college tuition. You can own the ROTH IRA but your children, grandchildren or great-grandchildren can use it for their own education expenses.
Requirement Minimum Distribution Rules
Your required minimum distribution is the minimum amount you must withdraw from your account each year. You generally have to start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA, or retirement plan account when you reach age 70½.
Roth IRAs do NOT require withdrawals at age 70½.
Inheritance Rules & Taxation
If you leave your Roth IRA to your spouse, he or she will receive it and can basically treat it as his or her own. Your spouse won’t be required to take distributions or pay taxes.
If you name one or more people other than your spouse as a beneficiary, they will need to withdraw a minimum amount each year. There are several methods for calculating how much they withdraw. The benefit of the Roth IRA, compared with the Traditional IRA, is that your beneficiaries do not pay income tax on the distributions if you held the account for more than five years.
Your beneficiaries can also control the amount of distributions and the time over which they take them, depending on how they do the calculations. Stretching out the IRA gives the funds decades of tax-free growth in a Roth IRA.
Deciding which assets to take in a divorce can be confusing and quite complex. A Certified Divorce Financial Analyst can help you with these decisions by illustrating the tax effects today and in the future. We can also help with our knowledge of divorce taxation. The team approach of legal counsel and financial advocacy is powerful in divorce. This could very well be the largest financial transaction of your life, it makes sense to have a financial advocate on your side.
For help navigating which asset to use for your divorce or other financial related issues during or after divorce, please call our office to schedule a complimentary consultation. We are happy to help you.