Understand taxes on IRA distributions

When you take a cash distribution from your IRA, you may owe income taxes on some or all of the amount you withdraw. The type of IRA you have—and the type of money inside it—determines what you owe.

Regardless of your withholding election, we report your distribution to the Internal Revenue Service (IRS) on Form 1099-R.

You generally owe income tax on pre-tax distributions from a traditional IRA or Simplified Employee Pension (SEP) IRA—unless you roll the money over into another qualified retirement account.

If you take a distribution before age 59½, you may also owe a 10% early-withdrawal penalty tax unless an exception applies.

Roth IRA distributions are more nuanced. Your contributions (the money you personally put in) are always tax- and penalty-free. However, earnings and conversion amounts may be taxable depending on when you withdraw them and whether the distribution is qualified.

If your distribution is non-qualified, the IRS uses ordering rules to determine which portion of the withdrawal is subject to taxes or penalties.

Know the difference between Roth IRA and Roth 401(k) rules

Roth 401(k) distributions do not follow the same ordering rules. Roth 401(k) distributions are always a pro-rata portion of contributions and earnings. The ordering rules described in this article apply only to Roth IRAs.

Understand Roth IRA ordering rules

You cannot choose whether your distribution comes from contributions or earnings. Instead, the IRS applies a set hierarchy across all of your Roth IRA accounts—even if they are at different financial institutions.

Here is the order the IRS applies:

• Contributory basis (your personal contributions): This is the total amount you have contributed to any Roth IRA over the years. It is always distributed tax- and penalty-free. Amounts you rolled over from a designated Roth account in an employer-sponsored plan are also included here. If that rollover would have been a qualified distribution at the time, the entire amount (including earnings) counts as a contributory basis. If it would not have been qualified, only the contribution portion counts—the earnings portion is treated as Roth IRA earnings.

• Conversion amounts, starting with the oldest year first: The next portion comes from any conversions you made from non-Roth accounts (like a traditional IRA or 401(k)).

  • Taxable at the time of conversion: Always distributed tax-free. However, if the distribution is not qualified and fewer than five years have passed since the conversion, the 10% early-withdrawal penalty may apply unless an exception applies.

  • Not taxable at the time of conversion: These are typically non-deductible traditional IRA contributions or after-tax 401(k) amounts. Always distributed tax- and penalty-free.

• Earnings: Distributed last. If the distribution is not qualified, earnings are subject to income tax and the 10% early-withdrawal penalty unless an exception applies. If the distribution is qualified, earnings are tax- and penalty-free.

Track your own Roth IRA basis

Because Roth IRAs are individual accounts, you are responsible for tracking what portion falls into each ordering category. Financial institutions holding your assets are not required to make this determination. Since the IRS aggregates all Roth IRAs for ordering rule purposes, your financial institutions often do not have the full information needed.

Because Roth IRA ordering rules can be complex, here are a few examples to help illustrate how they work.

Example 1—straightforward distribution

Tegan is 36 years old, does not have a penalty exemption, and has one Roth IRA that has been open since 2012.

• $8,000 annual contributions

• $2,000 earnings

Tegan takes a $9,000 distribution. Applying the ordering rules:

• Contributory basis: $8,000—tax- and penalty-free

• Conversion amounts: none in the account

• Earnings: $1,000—included in taxable income and subject to the 10% early-withdrawal penalty

Result: Of the $9,000, $1,000 is taxable income and subject to the penalty. $1,000 in earnings remains in the account.

Example 2—multiple accounts

Vislor is 60 years old and has two Roth IRAs. The first one was opened in 2018.

• Roth IRA A: $2,000 contributions, $300 earnings

• Roth IRA B: $6,000 contributions, $1,700 earnings

Vislor takes a $9,000 distribution. It does not matter which account the distribution comes from—all Roth IRAs are treated as one.

Combined totals: $8,000 contributions, $2,000 earnings.

Applying the ordering rules:

• Contributory basis: $8,000—tax- and penalty-free

• Conversion amounts: none in the account

• Earnings: $1,000—this would normally be taxable, but the distribution is qualified because Vislor is over age 59½

Result: The entire $9,000 is tax- and penalty-free. $1,000 in earnings remains in the account.

Example 3—conversions and rollovers

Peri is 52 years old, does not qualify for a penalty exemption, has three Roth IRAs, and made the first Roth IRA contribution in 1998.

• Roth IRA A: $7,000 contributions, $5,000 earnings

• Roth IRA B: $5,000 taxed conversion (2022), $5,000 untaxed conversion (2022), $18,000 taxed conversion (2023), $2,000 earnings

• Roth IRA C: $8,000 basis rollover from a designated Roth (would have been a qualified distribution), $1,000 earnings rollover from a designated Roth (would have been a qualified distribution), $500 earnings

Peri closes Roth IRA B and takes a $30,000 distribution. All three accounts are treated as one.

Combined totals:

• $7,000 annual contributions

• $5,000 taxed conversion (2022)

• $5,000 untaxed conversion (2022)

• $18,000 taxed conversion (2023)

• $8,000 basis rollover from designated Roth (qualified)

• $1,000 earnings rollover from designated Roth (qualified)

• $7,500 earnings

Applying the ordering rules:

• Contributory basis: $16,000—tax- and penalty-free. This includes the $7,000 in annual contributions and the $9,000 in rolled-over basis and earnings (rolled-over earnings are included because the rollover would have been a qualified distribution).

• Conversion amounts (2022):

  • Taxed conversion: $5,000—tax-free, but subject to the 10% early-withdrawal penalty

  • Untaxed conversion: $5,000—tax- and penalty-free

• Conversion amounts (2023):

  • Taxed conversion: $4,000—tax-free, but subject to the 10% early-withdrawal penalty

• Earnings: none taken—the $30,000 was fully covered by the categories above

Result: None of the $30,000 is included in taxable income, but $9,000 is subject to the 10% early-withdrawal penalty. After the distribution, $14,000 in taxed conversion assets (2023) and $7,500 in earnings remain.

When you request a cash distribution, we prompt you to make a withholding election. Withholding is a prepayment of income taxes—the amount withheld counts as a credit toward your overall tax liability for the year.

Your IRA distribution defaults to a 10% federal withholding rate. However, the 10% rate may not be right for your tax situation. You can choose a higher withholding rate or waive withholding altogether.

Learn more about the forms you may need to file with the IRS.

When withholding is required

In some cases, you cannot opt out of withholding:

• Certain states have minimum mandatory withholding requirements for IRA distributions.

• You cannot choose less than 10% federal withholding on any distribution delivered outside the United States.

• If you are a nonresident alien, you may be subject to a mandatory 30% withholding rate unless you submit a properly completed W-8BEN, and a valid tax treaty rate or exemption exists between the United States and your country of residence.