Publication 590: Individual Retirement Arrangements (IRAs); Chapter 2

This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

What's New for 2005

Roth IRA contribution limit. If contributions on your behalf are made only to Roth IRAs, your contribution limit for 2005 will generally be the lesser of:

$4,000, or
Your taxable compensation for the year.

If you are 50 or older in 2005 and contributions on your behalf are made only to Roth IRAs, your contribution limit for 2005 will generally be the lesser of:

$4,500, or
Your taxable compensation for the year.

However, if your modified AGI is above a certain amount, your contribution limit may be reduced. For more information, see How Much Can Be Contributed? under Can You Contribute to a Roth IRA?, later.

Reminder

Deemed IRAs. For plan years beginning after 2002, a qualified employer plan (retirement plan) can maintain a separate account or annuity under the plan (a deemed IRA) to receive voluntary employee contributions. If the separate account or annuity otherwise meets the requirements of an IRA, it will be subject only to IRA rules. An employee's account can be treated as a traditional IRA or a Roth IRA. For this purpose, a “qualified employer plan” includes:

A qualified pension, profit-sharing, or stock bonus plan (section 401(a) plan),
A qualified employee annuity plan (section 403(a) plan),
A tax-sheltered annuity plan (section 403(b) plan), and
A deferred compensation plan (section 457 plan) maintained by a state, a political subdivision of a state, or an agency or instrumentality of a state or political subdivision of a state.

Introduction

Regardless of your age, you may be able to establish and make nondeductible contributions to an individual retirement plan called a Roth IRA.

Contributions not reported. You do not report Roth IRA contributions on your return.

What is a Roth IRA?

A Roth IRA is an individual retirement plan that, except as explained in this chapter, is subject to the rules that apply to a traditional IRA (defined below). It can be either an account or an annuity. Individual retirement accounts and annuities are described in chapter 1 under How Can a Traditional IRA Be Set Up.

To be a Roth IRA, the account or annuity must be designated as a Roth IRA when it is set up. A deemed IRA can be a Roth IRA, but neither a SEP-IRA nor a SIMPLE IRA can be designated as a Roth IRA.

Unlike a traditional IRA, you cannot deduct contributions to a Roth IRA. But, if you satisfy the requirements, qualified distributions (discussed later) are tax free. Contributions can be made to your Roth IRA after you reach age 70½ and you can leave amounts in your Roth IRA as long as you live.

Traditional IRA. A traditional IRA is any IRA that is not a Roth IRA or SIMPLE IRA. Traditional IRAs are discussed in chapter 1.

When Can a Roth IRA Be Set Up?

You can set up a Roth IRA at any time. However, the time for making contributions for any year is limited. See When Can You Make Contributions, later under Can You Contribute to a Roth IRA.

Can You Contribute to a Roth IRA?

Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and your modified AGI (defined later) is less than:

$160,000 for married filing jointly or qualifying widow(er),
$10,000 for married filing separately and you lived with your spouse at any time during the year, and
$110,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year.

You may be eligible to claim a credit for contributions to your Roth IRA. For more information, see chapter 4.

Is there an age limit for contributions? Contributions can be made to your Roth IRA regardless of your age.

Can you contribute to a Roth IRA for your spouse? You can contribute to a Roth IRA for your spouse provided the contributions satisfy the spousal IRA limit (discussed in chapter 1 under How Much Can Be Contributed?), you file jointly, and your modified AGI is less than $160,000.

Compensation. Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services. It also includes commissions, self-employment income, and taxable alimony and separate maintenance payments. For more information, see What Is Compensation? under Who Can Set Up a Traditional IRA? in chapter 1.

Modified AGI. Your modified AGI for Roth IRA purposes is your adjusted gross income (AGI) as shown on your return modified as follows.

Subtract conversion income. This is any income resulting from the conversion of an IRA (other than a Roth IRA) to a Roth IRA. Conversions are discussed under Can You Move Amounts Into a Roth IRA, later.
Add the following deductions and exclusions:
1. Traditional IRA deduction,
2. Student loan interest deduction,
3. Tuition and fees deduction,
4. Foreign earned income exclusion,
5. Foreign housing exclusion or deduction,
6. Exclusion of qualified bond interest shown on Form 8815, and
7. Exclusion of employer-provided adoption benefits shown on Form 8839.

You can use Worksheet 2-1 to figure your modified AGI.

Do not subtract conversion income when figuring your other AGI-based phaseouts and taxable income, such as your deduction for medical and dental expenses. Subtract it from AGI only for the purpose of figuring your modified AGI for Roth IRA purposes.

How Much Can Be Contributed?

The contribution limit for Roth IRAs depends on whether contributions are made only to Roth IRAs or to both traditional IRAs and Roth IRAs.

Table 2-1. Effect of Modified AGI on Roth IRA Contribution This table shows whether your contribution to a Roth IRA is affected by the amount of your modified adjusted gross income (modified AGI).

This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

IF you have taxable compensation and your filing status is ...	AND your modified AGI is ...	THEN ...
married filing jointly or qualifying widow(er)	less than $150,000	you can contribute up to $3,000 ($3,500 if age 50 or older; for 2005, $4,000 or $4,500, if 50 or older) as explained under How Much Can Be Contributed.
	at least $150,000 but less than $160,000	the amount you can contribute is reduced as explained under Contribution limit reduced.
	$160,000 or more	you cannot contribute to a Roth IRA.
married filing separately and you lived with your spouse at any time during the year	zero (-0-)	you can contribute up to $3,000 ($3,500 if 50 or older; for 2005, $4,000 or $4,500, if 50 or older) as explained under How Much Can Be Contributed.
	more than zero (-0-) but less than $10,000	the amount you can contribute is reduced as explained under Contribution limit reduced.
	$10,000 or more	you cannot contribute to a Roth IRA.
single, head of household, or married filing separately and you did not live with your spouse at any time during the year	less than $95,000	you can contribute up to $3,000 ($3,500 if age 50 or older; for 2005, $4,000 or $4,500, if 50 or older) as explained under How Much Can Be Contributed.
	at least $95,000 but less than $110,000	the amount you can contribute is reduced as explained under Contribution limit reduced.
	$110,000 or more	you cannot contribute to a Roth IRA.

Roth IRAs only. If contributions are made only to Roth IRAs, your contribution limit generally is the lesser of:

$3,000 ($3,500 if you are 50 or older; for 2005, $4,000 or $4,500, if 50 or older), or
Your taxable compensation.

However, if your modified AGI is above a certain amount, your contribution limit may be reduced, as explained later under Contribution limit reduced.

Roth IRAs and traditional IRAs. If contributions are made to both Roth IRAs and traditional IRAs established for your benefit, your contribution limit for Roth IRAs generally is the same as your limit would be if contributions were made only to Roth IRAs, but then reduced by all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.

This means that your contribution limit is the lesser of:

$3,000 ($3,500 if you are 50 or older; for 2005, $4,000 or $4,500, if 50 or older) minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs, or
Your taxable compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.

However, if your modified AGI is above a certain amount, your contribution limit may be reduced, as explained next under Contribution limit reduced.

Simplified employee pensions (SEPs) are discussed in Publication 560. Savings incentive match plans for employees (SIMPLEs) are discussed in chapter 3.

Contribution limit reduced. If your modified AGI is above a certain amount, your contribution limit is gradually reduced. Use Table 2-1 to determine if this reduction applies to you.

Figuring the reduction. If the amount you can contribute must be reduced, figure your reduced contribution limit as follows.

Start with your modified AGI.
Subtract from the amount in (1):
1. $150,000 if filing a joint return or qualifying widow(er),
2. $-0- if married filing a separate return, and you lived with your spouse at any time during the year, or
3. $95,000 for all other individuals.
Divide the result in (2) by $15,000 ($10,000 if filing a joint return, qualifying widow(er), or married filing a separate return and you lived with your spouse at any time during the year).
Multiply the maximum contribution limit (before reduction by this adjustment and before reduction for any contributions to traditional IRAs) by the result in (3).
Subtract the result in (4) from the maximum contribution limit before this reduction. The result is your reduced contribution limit.

Worksheet 2-1. Modified Adjusted Gross Income for Roth IRA Purposes Use this worksheet to figure your modified adjusted gross income for Roth IRA purposes.

This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

1.	Enter your adjusted gross income (Form 1040, line 37 or Form 1040A, line 22)	1.
2.	Enter any income resulting from the conversion of an IRA (other than a Roth IRA) to a Roth IRA	2.
3.	Subtract line 2 from line 1	3.
4.	Enter any traditional IRA deduction (Form 1040, line 25 or Form 1040A, line 17)	4.
5.	Enter any student loan interest deduction (Form 1040, line 26 or Form 1040A, line 18)	5.
6.	Enter any tuition and fees deduction (Form 1040, line 27 or Form 1040A, line 19)	6.
7.	Enter any foreign earned income and/or housing exclusion (Form 2555, line 43 or Form 2555-EZ, line 18)	7.
8.	Enter any foreign housing deduction (Form 2555, line 48)	8.
9.	Enter any exclusion of bond interest (Form 8815, line 14)	9.
10.	Enter any exclusion of employer-provided adoption benefits (Form 8839, line 30)	10.
11.	Add the amounts on lines 3 through 10.	11.
12.	Enter: $160,000 if married filing jointly or qualifying widow(er) $10,000 if married filing separately and you lived with your spouse at any time during the year $110,000 for all others	12.
	Next. Is the amount on line 11 more than the amount on line 12? Yes. See the Note below. No. The amount on line 11 is your modified adjusted gross income for Roth IRA purposes.
	Note. If the amount on line 11 is more than the amount on line 12 and you have other income or loss items, such as social security income or passive activity losses, that are subject to AGI-based phaseouts, you can refigure your AGI solely for the purpose of figuring your modified AGI for Roth IRA purposes. Refigure your AGI without taking into account any income from conversions. (If you receive social security benefits, use Worksheet 1 in Appendix B to refigure your AGI.) Then go to list item 2) above under Modified AGI or line 4 above in Worksheet 2-1 to refigure your modified AGI. If you do not have other income or loss items subject to AGI-based phaseouts, your modified adjusted gross income for Roth IRA purposes is the amount on line 11 above.

You can use Worksheet 2-2 to figure the reduction.

Worksheet 2-2. Determining Your Reduced Roth IRA Contribution Limit

Before using this worksheet, check Table 2-1 to determine whether or not your Roth IRA contribution limit is reduced. If it is, use this worksheet to determine how much it is reduced.

1.	Enter your modified AGI for Roth IRA purposes	1.
2.	Enter: $150,000 if filing a joint return or qualifying widow(er) $0 if married filing a separate return and you lived with your spouse at any time in 2004 $95,000 for all others	2.
3.	Subtract line 2 from line 1	3.
4.	Enter: $10,000 if filing a joint return or qualifying widow(er) or married filing a separate return and you lived with your spouse at any time during the year $15,000 for all others	4.
5.	Divide line 3 by line 4 and enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.000	5.
6.	Enter the lesser of: $3,000 ($3,500 if 50 or older; for 2005, $4,000 or $4,500, if 50 or older), or Your taxable compensation	6.
7.	Multiply line 5 by line 6	7.
8.	Subtract line 7 from line 6. Round the result up to the nearest $10. If the result is less than $200, enter $200	8.
9.	Enter contributions for the year to other IRAs	9.
10.	Subtract line 9 from line 6	10.
11.	Enter the lesser of line 8 or line 10. This is your reduced Roth IRA contribution limit	11.

Round your reduced contribution limit up to the nearest $10. If your reduced contribution limit is more than $0, but less than $200, increase the limit to $200.

Example.

You are a 45-year-old, single individual with taxable compensation of $113,000. You want to make the maximum allowable contribution to your Roth IRA for 2004. Your modified AGI for 2004 is $100,000. You have not contributed to any traditional IRA, so the maximum contribution limit before the modified AGI reduction is $3,000. Using the steps described above, you figure your reduced Roth IRA contribution of $2,010 as shown on the following worksheet.

Worksheet 2-2. Example—Illustrated

Before using this worksheet, check Table 2-1 to determine whether or not your Roth IRA contribution limit is reduced. If it is, use this worksheet to determine how much it is reduced.

1.	Enter your modified AGI for Roth IRA purposes	1.	100,000
2.	Enter: $150,000 if filing a joint return or qualifying widow(er) $0 if married filing a separate return and you lived with your spouse at any time in 2004 $95,000 for all others	2.	95,000
3.	Subtract line 2 from line 1	3.	5,000
4.	Enter: $10,000 if filing a joint return or qualifying widow(er) or married filing a separate return and you lived with your spouse at any time during the year $15,000 for all others	4.	15,000
5.	Divide line 3 by line 4 and enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.00	5.	.333
6.	Enter the lesser of: $3,000 ($3,500 if 50 or older; for 2005, $4,000 or $4,500, if 50 or older), or Your taxable compensation	6.	3,000
7.	Multiply line 5 by line 6	7.	999
8.	Subtract line 7 from line 6. Round the result up to the nearest $10. If the result is less than $200, enter $200	8.	2,010
9.	Enter contributions for the year to other IRAs	9.	0
10.	Subtract line 9 from line 6	10.	3,000
11.	Enter the lesser of line 8 or line 10. This is your reduced Roth IRA contribution limit	11.	2,010

When Can You Make Contributions?

You can make contributions to a Roth IRA for a year at any time during the year or by the due date of your return for that year (not including extensions).

You can make contributions for 2004 by the due date (not including extensions) for filing your 2004 tax return. This means that most people can make contributions for 2004 by April 15, 2005.

What If You Contribute Too Much?

A 6% excise tax applies to any excess contribution to a Roth IRA.

Excess contributions. These are the contributions to your Roth IRAs for a year that equal the total of:

Amounts contributed for the tax year to your Roth IRAs (other than amounts properly and timely rolled over from a Roth IRA or properly converted from a traditional IRA, as described later) that are more than your contribution limit for the year (explained earlier under How Much Can be Contributed?), plus
Any excess contributions for the preceding year, reduced by the total of:
1. Any distributions out of your Roth IRAs for the year, plus
2. Your contribution limit for the year minus your contributions to all your IRAs for the year.

Withdrawal of excess contributions. For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made.

Applying excess contributions. If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year.

Can You Move Amounts Into a Roth IRA?

You may be able to convert amounts from either a traditional, SEP, or SIMPLE IRA into a Roth IRA. You may be able to recharacterize contributions made to one IRA as having been made directly to a different IRA. You can roll amounts over from one Roth IRA to another Roth IRA.

Conversions

You can convert a traditional IRA to a Roth IRA. The conversion is treated as a rollover, regardless of the conversion method used. Most of the rules for rollovers, described in chapter 1 under Rollover From One IRA Into Another, apply to these rollovers. However, the 1-year waiting period does not apply.

Conversion methods. You can convert amounts from a traditional IRA to a Roth IRA in any of the following three ways.

Rollover. You can receive a distribution from a traditional IRA and roll it over (contribute it) to a Roth IRA within 60 days after the distribution.
Trustee-to-trustee transfer. You can direct the trustee of the traditional IRA to transfer an amount from the traditional IRA to the trustee of the Roth IRA.
Same trustee transfer. If the trustee of the traditional IRA also maintains the Roth IRA, you can direct the trustee to transfer an amount from the traditional IRA to the Roth IRA.

Same trustee. Conversions made with the same trustee can be made by redesignating the traditional IRA as a Roth IRA, rather than opening a new account or issuing a new contract.

More information. For more information on conversions, see Converting From Any Traditional IRA Into a Roth IRA in chapter 1.

Failed Conversions

If, when you converted amounts from a traditional IRA or SIMPLE IRA into a Roth IRA, you expected to have modified AGI of less than $100,000 and a filing status other than married filing separately, but your expectations did not come true, you have made a failed conversion.

Results of failed conversions. If the converted amount (contribution) is not recharacterized (explained in chapter 1), the contribution will be treated as a regular contribution to the Roth IRA and subject to the following tax consequences.

A 6% excise tax per year will apply to any excess contribution not withdrawn from the Roth IRA.
The distributions from the traditional IRA must be included in your gross income.
The 10% additional tax on early distributions may apply to any distribution.

How to avoid. You must move the amount converted (including all earnings from the date of conversion) into a traditional IRA by the due date (including extensions) for your tax return for the year during which you made the conversion to the Roth IRA. You do not have to include this distribution (withdrawal) in income.

Rollover From a Roth IRA

You can withdraw, tax free, all or part of the assets from one Roth IRA if you contribute them within 60 days to another Roth IRA. Most of the rules for rollovers, described in chapter 1 under Rollover From One IRA Into Another, apply to these rollovers. However, rollovers from retirement plans other than Roth IRAs are disregarded for purposes of the 1-year waiting period between rollovers.

A rollover from a Roth IRA to an employer retirement plan is not allowed.

Are Distributions Taxable?

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s). You also do not include distributions from your Roth IRA that you roll over tax free into another Roth IRA. You may have to include part of other distributions in your income. See Ordering Rules for Distributions, later.

Basis of distributed property. The basis of property distributed from a Roth IRA is its fair market value (FMV) on the date of distribution, whether or not the distribution is a qualified distribution.

Withdrawals of contributions by due date. If you withdraw contributions (including any net earnings on the contributions) by the due date of your return for the year in which you made the contribution, the contributions are treated as if you never made them. If you have an extension of time to file your return, you can withdraw the contributions and earnings by the extended due date. The withdrawal of contributions is tax free, but you must include the earnings on the contributions in income for the year in which you made the contributions.

What Are Qualified Distributions?

A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and
The payment or distribution is:
1. Made on or after the date you reach age 59½,
2. Made because you are disabled,
3. Made to a beneficiary or to your estate after your death, or
4. One that meets the requirements listed under First home under Exceptions in chapter 1 (up to a $10,000 lifetime limit).

Is Roth Distributions a Qualified Distribution?

Additional Tax on Early Distributions

If you receive a distribution that is not a qualified distribution, you may have to pay the 10% additional tax on early distributions as explained in the following paragraphs.

Distributions of conversion contributions within 5-year period. If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted (the conversion contribution) that you had to include in income. A separate 5-year period applies to each conversion. See Ordering Rules for Distributions, later, to determine the amount, if any, of the distribution that is attributable to the part of the conversion contribution that you had to include in income.

The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion contribution is separately determined for each conversion, and is not necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution. See What Are Qualified Distributions, earlier.

For example, if a calendar-year taxpayer makes a conversion contribution on February 25, 1999, and makes a regular contribution for 1998 on the same date, the 5-year period for the conversion begins January 1, 1999, while the 5-year period for the regular contribution begins on January 1, 1998.

Unless one of the exceptions listed later applies, you must pay the additional tax on the portion of the distribution attributable to the part of the conversion contribution that you had to include in income because of the conversion.

You must pay the 10% additional tax in the year of the distribution, even if you had included the conversion contribution in an earlier year. You also must pay the additional tax on any portion of the distribution attributable to earnings on contributions.

Other early distributions. Unless one of the exceptions listed below applies, you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions.

Exceptions. You may not have to pay the 10% additional tax in the following situations.

You have reached age 59½.
You are disabled.
You are the beneficiary of a deceased IRA owner.
You use the distribution to pay certain qualified first-time homebuyer amounts.
The distributions are part of a series of substantially equal payments.
You have significant unreimbursed medical expenses.
You are paying medical insurance premiums after losing your job.
The distributions are not more than your qualified higher education expenses.
The distribution is due to an IRS levy of the qualified plan.

Most of these exceptions are discussed earlier in chapter 1 under Early Distributions.

Ordering Rules for Distributions

If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions) and earnings are considered to be distributed from your Roth IRA. For these purposes, disregard the withdrawal of excess contributions and the earnings on them (discussed earlier under What If You Contribute Too Much). Order the distributions as follows.

Regular contributions.
Conversion contributions, on a first-in-first-out basis (generally, total conversions from the earliest year first). See Aggregation (grouping and adding) rules, later. Take these conversion contributions into account as follows:
1. Taxable portion (the amount required to be included in gross income because of conversion) first, and then the
2. Nontaxable portion.
Earnings on contributions.

Disregard rollover contributions from other Roth IRAs for this purpose.

Aggregation (grouping and adding) rules. Determine the taxable amounts distributed (withdrawn), distributions, and contributions by grouping and adding them together as follows.

Add all distributions from all your Roth IRAs during the year together.
Add all regular contributions made for the year (including contributions made after the close of the year, but before the due date of your return) together. Add this total to the total undistributed regular contributions made in prior years.
Add all conversion contributions made during the year together. For purposes of the ordering rules, in the case of any conversion in which the conversion distribution is made in 2004 and the conversion contribution is made in 2005, treat the conversion contribution as contributed before any other conversion contributions made in 2005.

Add any recharacterized contributions that end up in a Roth IRA to the appropriate contribution group for the year that the original contribution would have been taken into account if it had been made directly to the Roth IRA.

Disregard any recharacterized contribution that ends up in an IRA other than a Roth IRA for the purpose of grouping (aggregating) both contributions and distributions. Also disregard any amount withdrawn to correct an excess contribution (including the earnings withdrawn) for this purpose.

How Do You Figure the Taxable Part?

To figure the taxable part of a distribution that is not a qualified distribution, complete Worksheet 2-3.

Worksheet 2-3. Figuring the Taxable Part of a Distribution (Other Than a Qualified Distribution) From a Roth IRA

1.	Enter the total of all distributions made from your Roth IRA(s) during the year	1.
2.	Enter the amount of qualified distributions made during the year	2.
3.	Subtract line 2 from line 1	3.
4.	Enter the amount of distributions made during the year to correct excess contributions made during the year. (Do not include earnings.)	4.
5.	Subtract line 4 from line 3	5.
6.	Enter the amount of distributions made during the year that were contributed to another Roth IRA in a qualified rollover contribution	6.
7.	Subtract line 6 from line 5	7.
8.	Enter the amount of all prior distributions from your Roth IRA(s) (whether or not they were qualified distributions)	8.
9.	Add lines 1 and 8	9.
10.	Enter the amount of the distributions included on line 8 that were previously includible in your income	10.
11.	Subtract line 10 from line 9	11.
12.	Enter the total of all your contributions to all of your Roth IRAs	12.
13.	Enter the total of all distributions made (this year and in prior years) to correct excess contributions. (Include earnings.)	13.
14.	Subtract line 13 from line 12. (If the result is less than 0, enter 0.)	14.
15.	Subtract line 14 from line 11. (If the result is less than 0, enter 0.)	15.
16.	Enter the smaller of the amount on line 7 or the amount on line 15. This is the taxable part of your distribution	16.

Example.

On October 15, 1999, Justin converted all $80,000 in his traditional IRA to his Roth IRA. His Forms 8606 from prior years show that $20,000 of the amount converted is his basis.

Justin included $60,000 ($80,000 - $20,000) in his gross income.

On February 23, 2004, Justin makes a regular contribution of $3,000 to a Roth IRA. On November 7, 2004, Justin takes a $5,000 distribution from his Roth IRA.

The first $3,000 of the distribution is a return of Justin's regular contribution and is not includible in his income.

The next $2,000 of the distribution is not includible in income because it was included previously.

Because the $2,000 is distributed after the end of the applicable 5-year period for a qualified distribution, it is not subject to the 10% additional tax on early distributions.

Justin does not have to file Form 5329 with his return to report an early distribution or figure additional tax or claim an exception.

Must You Withdraw or Use Assets?

You are not required to take distributions from your Roth IRA at any age. The minimum distribution rules that apply to traditional IRAs do not apply to Roth IRAs while the owner is alive. However, after the death of a Roth IRA owner, certain of the minimum distribution rules that apply to traditional IRAs also apply to Roth IRAs as explained later under Distributions After Owner's Death.

Minimum distributions. You cannot use your Roth IRA to satisfy minimum distribution requirements for your traditional IRA. Nor can you use distributions from traditional IRAs for required distributions from Roth IRAs. See Distributions to beneficiaries, later.

Recognizing Losses on Investments

If you have a loss on your Roth IRA investment, you can recognize the loss on your income tax return, but only when all the amounts in all of your Roth IRA accounts have been distributed to you and the total distributions are less than your unrecovered basis. Your basis is the total amount of contributions in your Roth IRAs. You claim the loss as a miscellaneous itemized deduction, subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions on Schedule A, Form 1040.

Distributions After Owner's Death

If a Roth IRA owner dies, the minimum distribution rules that apply to traditional IRAs apply to Roth IRAs as though the Roth IRA owner died before his or her required beginning date. See When Can You Withdraw or Use Assets? in chapter 1.

Distributions to beneficiaries. Generally, the entire interest in the Roth IRA must be distributed by the end of the fifth calendar year after the year of the owner's death unless the interest is payable to a designated beneficiary over the life or life expectancy of the designated beneficiary. (See When Must You Withdraw Assets? (Required Minimum Distributions) in chapter 1.)

If paid as an annuity, the entire interest must be payable over a period not greater than the designated beneficiary's life expectancy and distributions must begin before the end of the calendar year following the year of death. Distributions from another Roth IRA cannot be substituted for these distributions unless the other Roth IRA was inherited from the same decedent.

If the sole beneficiary is the spouse, he or she can either delay distributions until the decedent would have reached age 70½, or treat the Roth IRA as his or her own.

Combining with other Roth IRAs. A beneficiary can combine an inherited Roth IRA with another Roth IRA maintained by the beneficiary only if the beneficiary either:

Inherited the other Roth IRA from the same decedent, or
Was the spouse of the decedent and the sole beneficiary of the Roth IRA and elects to treat it as his or her own IRA.

Distributions that are not qualified distributions. If a distribution to a beneficiary is not a qualified distribution, it is generally includible in the beneficiary's gross income in the same manner as it would have been included in the owner's income had it been distributed to the IRA owner when he or she was alive.

If the owner of a Roth IRA dies before the end of:

The 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for the owner's benefit, or
The 5-year period starting with the year of a conversion contribution from a traditional IRA to a Roth IRA,

each type of contribution is divided among multiple beneficiaries according to the pro-rata share of each. See Ordering Rules for Distributions, earlier in this chapter under Are Distributions Taxable.

Example.

When Ms. Hibbard died in 2004, her Roth IRA contained regular contributions of $4,000, a conversion contribution of $10,000 that was made in 2000, and earnings of $2,000. No distributions had been made from her IRA. She had no basis in the conversion contribution in 2000.

When she established her Roth IRA, she named each of her 4 children as equal beneficiaries. Each child will receive one-fourth of each type of contribution and one-fourth of the earnings. An immediate distribution of $4,000 to each child will be treated as $1,000 from regular contributions, $2,500 from conversion contributions, and $500 from earnings.

In this case, because the distributions are made before the end of the applicable 5-year period for a qualified distribution, each beneficiary includes $500 in income for 2004. The 10% additional tax on early distributions does not apply because the distribution was made to the beneficiaries as a result of the death of the IRA owner.

Tax on excess accumulations (insufficient distributions). If distributions from an inherited Roth IRA are less than the required minimum distribution for the year, discussed in chapter 1 under When Must You Withdraw Assets? (Required Minimum Distributions), you may have to pay a 50% excise tax for that year on the amount not distributed as required. For the tax on excess accumulations (insufficient distributions), see Excess Accumulations (Insufficient Distributions) under What Acts Result in Penalties or Additional Taxes? in chapter 1. If this applies to you, substitute “Roth IRA” for “traditional IRA” in that discussion.

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Chapter 2 - Roth IRAs