Divorce itself is an emotionally charged, troubling process. Add major financial decisions to the mix and divorce can be a recipe for disaster. Litigants are forced to make life altering financial decisions during a time of emotional turmoil. Anyone walking through divorce knows this can feel like an insurmountable task. There is hope! You can do this!

Our next few articles will focus on different types of assets we see divided on a regular basis in divorce. We will discuss the different types of financial accounts, their tax benefits or consequences and their pros and cons.

The ROTH IRA is a powerful financial tool which differs in many ways from a Traditional IRA or a Rollover IRA. The ROTH IRA can be used for a variety of needs sometimes without taxation or penalties. If you have a ROTH IRA to divide in your divorce you have potential access to a powerful financial tool.

Withdrawals of Contributions

In general, withdrawals of ROTH IRA contributions, or the tax basis, can be taken anytime, tax- and penalty-free. You can specifically request the ROTH IRA contributions be distributed and ask the fund company to leave the earnings alone.

It is important to know what portion of the ROTH IRA value is from contributions (or the cost basis) and what part of the ROTH IRA is attributable to earnings. Ask your attorney to request that information in the divorce process if you do not have it. You will need this information for your CPA at tax time if you request a distribution from your ROTH IRA. You will need this information whether you use the ROTH IRA now or years into the future. Make sure you know the cost basis if you receive the ROTH IRA in your divorce.

Withdrawals of Earnings

You may have to pay taxes and penalties on earnings in your Roth IRA. Taxes and penalties on the earnings are dependent not only on an exclusion list but also dependent on how long you have had the ROTH IRA. There is a five-year rule for owning the ROTH IRA regarding distributions of earnings.

The five-year rule for your Roth IRA earnings starts on January 1st of the year you make your first contribution. That is when your clock starts. Because you can make a Roth IRA contribution up to April 15th of the next year, your five years technically would not have to be five calendar years. The clock for earnings could count as having started on January 1st as long as you designated contributions up until April 15th for the previous tax year.  For example, if you made a Roth IRA contribution in February 2019 and designated it for the 2018 tax year, you would have to wait only until January 1st, 2023 to complete the five-year rule requirement.

Withdrawals of earnings – age 59 and under:

Withdrawals from a Roth IRA you’ve had less than five years.
If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and penalties. You may be able to avoid penalties (but not taxes) in the following situations:
• You use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.
• You use the withdrawal to pay for qualified education expenses.
• You’re at least age 59½.
• You become disabled or pass away.
• You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.
• The distribution is made in substantially equal periodic payments.

Withdrawals from a Roth IRA you’ve had more than five years.
If you’re under age 59½ and your Roth IRA has been open five years or more, your earnings will not be subject to taxes if you meet one of the following conditions:
• You use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.
• You’re at least age 59½.
• You become disabled or pass away.
• You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.
• The distribution is made in substantially equal periodic payments.

Withdrawals of earnings – age 59½ to 70:

Withdrawals from a Roth IRA you’ve had less than five years.
If you haven’t met the five-year holding requirement, your earnings will be subject to taxes but not penalties.

Withdrawals from a Roth IRA you’ve had more than five years.
If you’ve met the five-year holding requirement, you can withdraw money from a Roth IRA with no taxes or penalties.

Withdrawals of earnings – age 70½ and over:

Withdrawals from a Roth IRA you’ve had less than five years.
If you haven’t met the five-year holding requirement, your earnings will be subject to taxes but not penalties.

Withdrawals from a Roth IRA you’ve had more than five years.
If you’ve met the five-year holding requirement, you can withdraw money from a Roth IRA with no taxes. Required minimum distributions are not mandated on ROTH IRA’s like they are Traditional and Rollover IRA’s when you are 70½.

In summation, the ROTH IRA is a varied, flexible tool. It is a powerful tool that can provide tax free income for you at many different stages of life. In addition, if you do not have a lot of non-retirement funds to use for funding your divorce process the ROTH IRA is an option for tax-free and penalty-free distributions (when you use the cost basis).