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How and when does money leave an IRA?
This material is intended as general information only and is not intended as legal or tax advice. Some of this information may be quite complex and we strongly suggest you consult with your advisor or tax professional based on your individual situation.
Unless the participant is using Roth dollars that were converted from a traditional IRA, it is unlikely that any taxable dollars would be withdrawn under this option, as the ordering rules on Roth IRA withdrawals is basis first (the money the individual contributed), conversion dollars, and then earnings.
The $10,000 withdrawal for first-time homebuyers from a Roth IRA is a tax-free distribution if the account has been in existence for five years. In addition, the participant can withdraw his or her non-taxable basis at any time and for any reason, so the $10,000 limit only comes into play when earnings (dollars above basis) are being withdrawn or the withdrawal consists of dollars that were taxable when converted to a Roth IRA from a traditional IRA and five years have not yet passed.
1 Adjusted Gross Income includes wages, interest, capital gains, income from retirement accounts and alimony paid to the taxpayer adjusted downward by specific deductions (including contributions to deductible retirement accounts and alimony paid by the taxpayer); but not including standard and itemized deductions.
If the Roth IRA is inherited from someone other than a spouse, the options are more limited. The beneficiary may leave the account where it is or make a trustee-to-trustee transfer (to change investment vehicle from one Roth IRA trustee [custodian] directly to another) as long as the Roth IRA is established in the name of the deceased owner for the benefit of the beneficiary. For example the account might be titled as follows: "Joe Doe, deceased, Roth IRA, F/B/O Jane Doe, beneficiary."If you are a non-spouse beneficiary, you have the option to:
A Stretch IRA (applies to Roth and traditional IRAs) can be described as a distribution strategy for an individual IRA's beneficiary. The objective upon the account owner's death is to S-T-R-E-T-C-H the beneficiary's payments over a lengthy period of time in order to obtain favorable economic and tax results. Payment projections over 30 years or more are not uncommon. The beneficiary is usually a child or a grandchild of the account owner, but may be anyone the owner chooses. There can be no guarantee, however, that the second- and third-generation beneficiaries will continue the stretch strategy and may elect to liquidate the account at any time.
Withdrawals from Roth IRAs are basis first (see above). If the minimum amount under the Stretch Roth IRA option is withdrawn each year, including any years before the account has been in existence for at least five years, it is unlikely that any withdrawals will be taxable.
Someone may want to S-T-R-E-T-C-H their distributions because money in a Roth IRA grows tax-deferred1 and potentially tax free. The beneficiary effectively inherits a tax-deferred,1 potentially tax free, savings account. By spreading the payments over a significant number of years tax deferred, potentially tax free, compounding continues, and if the account has been in existence for five years when a withdrawal is made, including the time the original owner held the account, all payments are tax free.
The regulations prohibit death distributions to extend beyond the period of the initial non-spouse beneficiary's life expectancy, not recalculated as they age.
Example: Martha dies and her daughter Angela is the beneficiary of her Roth IRA. Angela is 50 years old and her life expectancy is 34 years. In other words, Angela would need to withdraw 1/34, 1/33, 1/32, etc., of the account beginning on or before December 31st of the year following Martha's death.
If Angela dies five years later at age 55 and Angela's beneficiary is her son Bob, Bob can continue taking distributions based on Angela's reduced life expectancy (34-5= 29). If Bob were to pass away before the 29 years were over, he could pass on the Roth IRA to his beneficiary until the original life expectancy of Angela goes down to one, when the remaining balance would be fully distributed.
Unless restricted by the terms of the beneficiary designation, Angela, and subsequently Bob in this example, could accelerate their payments (take more than the minimum) which could lower the ultimate amount and length of the distributions. In addition, if this withdrawal period was less than five years from the time the Roth IRA was established, including the time the original account owner held the account, then any earnings accumulated on the account could be taxable if basis was exhausted.
If Martha did not name a beneficiary, the Roth IRA assets may have passed on to her estate with accelerated distributions being required. Some custodial account agreements may establish a beneficiary ordering rule, such as spouse, children, parents, etc., which could determine the actual beneficiary in the event the account owner did not have a named beneficiary upon death. Lord Abbett Roth IRAs designate the estate as beneficiary if one is unnamed at the time of death.
It is also important to note that Roth IRAs cannot be transferred via your will unless the will had been named, prior to death, as the beneficiary or contingent beneficiary of the account and accepted by the custodian.
1 Income whose taxes can be postponed until a later date; examples include IRAs and 401(k) plan earnings.
Risks Involving the Stretch IRA Strategy
Withdrawals by you or beneficiaries in excess of the required minimum distribution (RMD) will exhaust the account at a faster pace, reducing or eliminating the effectiveness of the stretch strategy. Distributions greater than the RMD could subject the payments to higher federal and possibly state income taxes. When investing assets, which will be used to stretch IRA payments, the investor must be cognizant of any front-end or back-end sales charges that can reduce the assets available. During an extended period of declining investment returns, investors will experience income fluctuations that may cause additional withdrawals to be made that will exhaust the account at a more rapid rate. There can be no guarantee that a Stretch IRA strategy will be advantageous to your specific situation, and many of its benefits are based on current tax laws, which are subject to change. If these laws change, an investor's ability to maintain estimated distributions may be affected. Lengthy distribution periods, much like those involved in a Stretch IRA, expose an investor to significant market risk.
Example: Barbara withdraws $30,000 from her Roth IRA on March 1, 2012. If she returns the $30,000, or a lesser amount, by April 30, 2012, she has had use of the money, preserved whatever basis is attached to the 2withdrawal, and avoided any taxes or penalties on any amounts exceeding her basis. She cannot make another withdrawal, with the ability to return it, until March 2, 2013.
Individuals must recognize there can be significant taxes and penalties if the funds are not repaid, and larger withdrawals may be more difficult to repay.
If Barbara had another Roth IRA (or several), she could make this 60-day withdrawal from each of them, at different times, use the funds as she wishes, and return them within the 60-day period.
Withdrawing funds from one Roth IRA and repaying it to another Roth IRA connects the second Roth IRA to the first Roth IRA for purposes of the 60-day rule. If Barbara had two Roth IRAs and withdrew from one, but repaid the other on a timely basis, she would lose the ability to make a separate 60-day withdrawal/return from the second IRA until March 2, 2013, in this example.
Lord Abbett will waive (or otherwise pay) the yearly $10.00 custodial fee that would be charged each year on an ongoing basis to every new IRA account and, therefore, will not assess a custodial account fee effective in 2013 or any year afterward. Fund level fees and expenses are still applicable. Please see the current prospectus.