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Author: wintbill Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121061  
Subject: Taxes/Penalties on Roth IRA distributions Date: 11/6/2002 12:06 PM
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I have two questions regarding taxes and penalties on Roth IRA distributions. After reading IRS publication 590 ( http://www.irs.gov/pub/irs-pdf/p590.pdf ), I have not yet found the answer I'm looking for.

Here's an example. In 2000, Jane contributes $1000 to a Roth IRA. Now in 2002, the value of the assets in the Roth IRA has fallen to $500. For simplicity, assume that over the course of two years, no assets in the account produced any income or gains in the form of dividend payments.

1) If Jane withdraws the $500 and liquidates the Roth IRA, what amount of the distribution, if any, is subject to taxes and/or penalties? If I understand correctly, the $500 does not exceed Jane's original contribution of $1000. However, Pub 590 only discusses that distributions of any amount of contributions made within the same tax year are considered as if no contribution was ever made. But in the above example, the distribution is not made in the same year of the contribution. So is the $500 distribution subject to early withdrawal penalties? My reasoning says no. I also assume that no amount of the distribution is subject to taxes, as there are no earnings in the account. Is this assumption correct?

2) Now, Jane originally contributed $1000, and now only has $500 to show for it after liquidating the Roth IRA. Can this be considered a capital loss? If so, how would it be reported? If not, why is it not considered a capital loss?

Thanks in advance,
Bill
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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61940 of 121061
Subject: Re: Taxes/Penalties on Roth IRA distributions Date: 11/6/2002 12:19 PM
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If Jane withdraws the $500 and liquidates the Roth IRA, what amount of the distribution, if any, is subject to taxes and/or penalties?

No. You can withdraw your Roth contributions at any time with out tax or penalty.

However, Pub 590 only discusses that distributions of any amount of contributions made within the same tax year are considered as if no contribution was ever made.

That's more of a reporting issue. If the money goes in and out in the same year, there's no reporting needed. If the in and out are in different years, both the contribution and the withdrawl need to be reported, but there is no tax or penalty.

Can this be considered a capital loss? If so, how would it be reported? If not, why is it not considered a capital loss?

It is not a capital loss, because an IRA is not a capital asset. If this were the only Roth IRA account, you could claim a miscellaneous itemized deduction for the loss.

--Peter

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Author: vkg Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61942 of 121061
Subject: Re: Taxes/Penalties on Roth IRA distributions Date: 11/6/2002 12:31 PM
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Bill,

2.) Losses on retirement plans are not reported on Schedule D. If the loss is significant and all ROTH IRAs are closed then part of the loss might be reportable as an itemized deduction on schedule A. The loss is included in miscellenous deductions on schedule A and only the amount over 2% of income is include in itemized deductions.

1.) Contributions can be withdrawn at any time without penalty. If the ROTH value is less than the contributions then no penalties would apply.

Debra

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Author: MarleysGhost Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61943 of 121061
Subject: Re: Taxes/Penalties on Roth IRA distributions Date: 11/6/2002 12:44 PM
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1) If Jane withdraws the $500 and liquidates the Roth IRA, what amount of the distribution, if any, is subject to taxes and/or penalties?

$500 would be subject to early distribution penalty if Jane has not yet reached age 59.5 as of the date of the withdrawl, and the money has not been in the Roth for at least five years. Since there was no tax deduction upon contribution, the $500 is not included in taxable income for the year of withdrawl.

contributions made within the same tax year are considered as if no contribution was ever made.

I believe this would apply only if she "recharacterizes" the Roth contribution as a Traditional IRA contribution, not to "liquidated" Roths. If by liquidation you mean taking the money out and neither recharacterizing to a Traditional or rolling over to another Roth.

2) Now, Jane originally contributed $1000, and now only has $500 to show for it after liquidating the Roth IRA. Can this be considered a capital loss? If so, how would it be reported? If not, why is it not considered a capital loss?

In order to claim a capital loss you must be eligible to itemize your deductions. Basis minus distribution = claimable loss. From IRS Pub 590...If you have a loss on your traditional IRA investment, you can recognize the loss on your income tax return, but only when all the amounts in all your traditional IRA accounts have been distributed to you and the total distributions are less than your unrecovered basis, if any. Your basis is the total amount of the nondeductable contributions in your traditional IRA's. You claim the loss as a miscellaneous deduction, subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions on Schedule A, Form 1040. A similar rule applies to Roth IRAs. The rule applies separately to each kind of IRA. Thus to report a loss in a Roth IRA, all the Roth IRA's (but not traditional IRAs) owned by you have to be liquidated, and to report a loss in a traditional IRA, all the traditional IRAs (but not the Roth IRAs) owned by you have to be liquidated.


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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61945 of 121061
Subject: Re: Taxes/Penalties on Roth IRA distributions Date: 11/6/2002 12:57 PM
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$500 would be subject to early distribution penalty if Jane has not yet reached age 59.5 as of the date of the withdrawl, and the money has not been in the Roth for at least five years.

No. You're describing the penalty for earnings in a Roth IRA, not the contributions. Since the account had no earnings, you can't withdraw earnings.

Just to recap the income and penalties on Roths:

Annual contrubutions: No income or penalty on withdrawl
Rollover contributions from a traditional IRA: No income tax on withdrawl. (The tax was paid at the time of rollover). Penalty applies if the money hasn't been in for five years OR if the owner is not yet 59 1/2.
Earnings: Penalty applies unless the account has been open for 5 years AND the owner is over 59 1/2. Taxable income unless it's a qualified withdrawl.

There's also some ordering rules. Withdrawls come first from annual contributions, then rollover contributions, then earnings.

In order to claim a capital loss you must be eligible to itemize your deductions.

Only half right. It's not a capital loss, by definition. But it can be a miscellaneous itemized deduction, subject to the 2% of AGI limitation.

--Peter

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Author: MarleysGhost Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 61946 of 121061
Subject: Re: Taxes/Penalties on Roth IRA distributions Date: 11/6/2002 1:05 PM
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Peter-
You're right. Thanks for setting me straight on that penalty on the earnings only.

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