By Sarah Brenner, JD
Director of Retirement Education
Question: I established a Roth IRA in 2011 and needed to withdraw $ 30,000 in 2021 to pay for my daughter’s first year of college tuition. I am under 59 1/12 and the 1099-R has a code of J meaning early distribution and no known exception. Will my distribution, therefore, be fully taxable and will I have to pay the 10% early withdrawal penalty? I was told by the Company holding my Roth IRA that it would be a fully NON-taxable distribution and no penalty as it was used for educational purposes. Please advise. Thank you
Answer: Determining the taxation of a Roth IRA distribution can be confusing. You must apply the Roth IRA ordering rules. Any contributions you have made over the years come out first. Those are always tax and penalty free. Your conversion dollars come out of the Roth IRA next and are always tax-free but can be subject to penalty if you are under age 59 ½. However, an exception does apply if you use the funds for higher education.
The last money out of a Roth IRA would be any accumulated earnings. Unfortunately, a distribution of earnings taken when you are under age 59 ½ that is used to pay for higher education would be taxable, although it would not be subject to penalty. All of your Roth IRAs are aggregated when applying the Roth IRA ordering rules, and you can use Form 8606 to determine the taxation of your distribution.
Question: Can I do a nondeductible contribution and conversion before having any pre-tax rollover contributions and after converting it to the Roth IRA, roll over my pre-tax 401k into an empty IRA a month later, without triggering the pro rata rule since at the time of the backdoor conversion there was no pre-tax monies in any IRA?
Answer: Unfortunately, that timing would not avoid the pro rata formula. That is because any funds that are rolled into the IRA later in the year are included when applying the formula. The balance at the end of the year, with some adjustments, is what is used on Form 8606 when determining the taxation of a conversion.