Tax Question ROTH Principal Withdrawal

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Cloud
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Tax Question ROTH Principal Withdrawal

Post by Cloud »

Early retiree and have been living on cash and investment savings for years now. Still not 59 1/2. This year we withdrew a substantial amount from our ROTH (return of principal and meets the 5 year rule) to purchase a second home.

Just starting my taxes and it's my understanding there's no place to report this withdrawal of principal. Will vanguard send or report anything? It feels so strange that there's no reporting to be done at tax time. How does the IRS know when I exceed the original principal or break a 5 year rule. Of course we've always completed, yearly, form 8606 for all ROTH conversions.

Form 8606 states "For this purpose, a distribution does not include ... ... ... , or return of certain contributions (see instructions)."

Line 19
Don’t include on line 19 any of the following.
Distributions that are a return of contributions under Return of IRA Contributions, earlier.

Am I missing anything?

Thanks!
cas
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Re: Tax Question ROTH Principal Withdrawal

Post by cas »

A "Return of Contribution" is something different from a "distribution of a regular contribution". It is when you make a contribution for a year, but then, before the tax return due date for that year, ask for it to be returned to you (often because you realize you didn't qualify to make the contribution to start with):

The 2020 version of the 8606 instructions, but the 2021 instructions will say the same thing with the year changed:
Return of IRA Contributions

If, in 2020, you made traditional IRA contributions or Roth IRA contributions for 2020 and you had those contributions returned to you with any related earnings (or minus any loss) by the due date (including extensions) of your 2020 tax return, the returned contributions are treated as if they were never contributed.
Last edited by cas on Thu Dec 02, 2021 3:30 pm, edited 1 time in total.
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samsoes
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Re: Tax Question ROTH Principal Withdrawal

Post by samsoes »

Is this for 2021? You will receive a 1099-R with appropriate codes and boxes checked. Your tax software will calculate the portion of the distribution (all, in this case) which is from contributions and populate form 8606 accordingly. Hopefully your tax software has been tracking your Roth contributions all along.
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Cloud
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Re: Tax Question ROTH Principal Withdrawal

Post by Cloud »

samsoes wrote: Thu Dec 02, 2021 3:27 pm Is this for 2021? You will receive a 1099-R with appropriate codes and boxes checked. Your tax software will calculate the portion of the distribution (all, in this case) which is from contributions and populate form 8606 accordingly. Hopefully your tax software has been tracking your Roth contributions all along.
Thanks. I have all contributions tracked in a spreadsheet. Just starting using tax software a few years ago.
pshonore
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Re: Tax Question ROTH Principal Withdrawal

Post by pshonore »

samsoes wrote: Thu Dec 02, 2021 3:27 pm Is this for 2021? You will receive a 1099-R with appropriate codes and boxes checked. Your tax software will calculate the portion of the distribution (all, in this case) which is from contributions and populate form 8606 accordingly. Hopefully your tax software has been tracking your Roth contributions all along.
I would not count on the software making those calculations. And certainly not if the original contributions were not input when made; since OP has only used tax software for a few years that's likely the case. However as long as he withdrew less than the total of his spreadsheet showing contributions, he should be ok.
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Cloud
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Re: Tax Question ROTH Principal Withdrawal

Post by Cloud »

I wish I knew what codes and boxes were going to be checked so I can fill everything out now. :(
secondcor521
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Re: Tax Question ROTH Principal Withdrawal

Post by secondcor521 »

You'll need to complete Part III of Form 8606.

The amount you took out goes on line 19.

The total of your contributions goes on line 22.

The total of your seasoned conversions goes on line 24.

At the end of everything, you should end up with a zero on line 25c.

The IRS can figure everything out from your properly completed Form 8606s, and the 1099-Rs and Form 5498s from the custodians over the years. If they want to, which I don't know if they do.

Vanguard will send you a Form 1099-R in late January-ish showing the withdrawn amount. I'm not sure what code(s) they will put in box 2.
MarkNYC
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Re: Tax Question ROTH Principal Withdrawal

Post by MarkNYC »

Cloud wrote: Thu Dec 02, 2021 6:07 pm I wish I knew what codes and boxes were going to be checked so I can fill everything out now. :(
In box 7 of the Form 1099-R that you receive, it should show distribution code "J" = distribution from a Roth IRA prior to age 59.5.
lstone19
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Re: Tax Question ROTH Principal Withdrawal

Post by lstone19 »

pshonore wrote: Thu Dec 02, 2021 5:17 pm I would not count on the software making those calculations. And certainly not if the original contributions were not input when made; since OP has only used tax software for a few years that's likely the case. However as long as he withdrew less than the total of his spreadsheet showing contributions, he should be ok.
Turbotax will track Roth contributions and conversions fro year to year. Someone new to TT can populate the IRA Information Worksheet with their past Roth contribution and conversion data in Part V (Prior Year balances (Basis before Current Year transactions)) and TT will then do what is needed.
newacct
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Re: Tax Question ROTH Principal Withdrawal

Post by newacct »

secondcor521 wrote: Thu Dec 02, 2021 7:54 pm The total of your seasoned conversions goes on line 24.
Non-seasoned conversions go there too; it's just that non-seasoned conversions may also trigger a penalty, to be filled out on form 5329
Alan S.
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Re: Tax Question ROTH Principal Withdrawal

Post by Alan S. »

Cloud wrote: Thu Dec 02, 2021 3:07 pm Early retiree and have been living on cash and investment savings for years now. Still not 59 1/2. This year we withdrew a substantial amount from our ROTH (return of principal and meets the 5 year rule) to purchase a second home.
FYI - the Roth 5 year period is immaterial in this situation, as there is no waiting period to withdraw regular Roth contributions tax and penalty free.

You may have read about the "first home" exception under which a first time homebuyer of a MAIN HOME can take qualified distributions from a Roth IRA up to 10,000 which can include tax free earnings. This does not apply to a second home, therefore you would not report any of this distribution on line 20 of Form 8606.
secondcor521
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Re: Tax Question ROTH Principal Withdrawal

Post by secondcor521 »

newacct wrote: Fri Dec 03, 2021 11:08 am
secondcor521 wrote: Thu Dec 02, 2021 7:54 pm The total of your seasoned conversions goes on line 24.
Non-seasoned conversions go there too; it's just that non-seasoned conversions may also trigger a penalty, to be filled out on form 5329
Thank you for the correction! :sharebeer
capran
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Re: Tax Question ROTH Principal Withdrawal

Post by capran »

Alan S. wrote: Fri Dec 03, 2021 11:24 am
Cloud wrote: Thu Dec 02, 2021 3:07 pm Early retiree and have been living on cash and investment savings for years now. Still not 59 1/2. This year we withdrew a substantial amount from our ROTH (return of principal and meets the 5 year rule) to purchase a second home.
FYI - the Roth 5 year period is immaterial in this situation, as there is no waiting period to withdraw regular Roth contributions tax and penalty free.

You may have read about the "first home" exception under which a first time homebuyer of a MAIN HOME can take qualified distributions from a Roth IRA up to 10,000 which can include tax free earnings. This does not apply to a second home, therefore you would not report any of this distribution on line 20 of Form 8606.
Alan, We have been discussing with adult child about using Roth money to help buy a home (down payment). Do you have a source for reading about the 10,000 limit? I had thought he could withdraw all his contributions to make home purchase, but not his interest/dividends, without penalty. Pretty dismayed to think he can only access 10k and would appreciate some sources we can follow up on. Thanks
edit: I did a quick search and an article on SoFi and one in Forbes suggests you can withdraw all contributions for any reason, but there was a suggestion that the earnings up to 10,000 may also be withdrawn for first home purchase, but may be subject to income tax.
sycamore
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Re: Tax Question ROTH Principal Withdrawal

Post by sycamore »

capran wrote: Fri Dec 03, 2021 9:44 pm
Alan S. wrote: Fri Dec 03, 2021 11:24 am
Cloud wrote: Thu Dec 02, 2021 3:07 pm Early retiree and have been living on cash and investment savings for years now. Still not 59 1/2. This year we withdrew a substantial amount from our ROTH (return of principal and meets the 5 year rule) to purchase a second home.
FYI - the Roth 5 year period is immaterial in this situation, as there is no waiting period to withdraw regular Roth contributions tax and penalty free.

You may have read about the "first home" exception under which a first time homebuyer of a MAIN HOME can take qualified distributions from a Roth IRA up to 10,000 which can include tax free earnings. This does not apply to a second home, therefore you would not report any of this distribution on line 20 of Form 8606.
Alan, We have been discussing with adult child about using Roth money to help buy a home (down payment). Do you have a source for reading about the 10,000 limit? I had thought he could withdraw all his contributions to make home purchase, but not his interest/dividends, without penalty. Pretty dismayed to think he can only access 10k and would appreciate some sources we can follow up on. Thanks
edit: I did a quick search and an article on SoFi and one in Forbes suggests you can withdraw all contributions for any reason, but there was a suggestion that the earnings up to 10,000 may also be withdrawn for first home purchase, but may be subject to income tax.
I think you may have misread -- Alan's statement about the $10k was in regard to the earnings, not contributions.

1) You can withdraw regular contributions without tax or penalty.
2) You can also withdraw earnings early but that would be subject to income tax and the additional 10% penalty/tax.
3) However, in the case of withdrawing earnings early for a first-time homebuyer, $10,000 of the earnings are not subject to the additional 10% penalty/tax.

References:
https://www.irs.gov/pub/irs-pdf/i5329.pdf - see section "Exceptions to the Additional Tax on Early Distributions", number 09.
https://www.bogleheads.org/wiki/Roth_IRA#Distributions
capran
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Re: Tax Question ROTH Principal Withdrawal

Post by capran »

sycamore wrote: Sat Dec 04, 2021 6:18 am
capran wrote: Fri Dec 03, 2021 9:44 pm
Alan S. wrote: Fri Dec 03, 2021 11:24 am
Cloud wrote: Thu Dec 02, 2021 3:07 pm Early retiree and have been living on cash and investment savings for years now. Still not 59 1/2. This year we withdrew a substantial amount from our ROTH (return of principal and meets the 5 year rule) to purchase a second home.
You may have read about the "first home" exception under which a first time homebuyer of a MAIN HOME can take qualified distributions from a Roth IRA up to 10,000 which can include tax free earnings.
Alan, We have been discussing with adult child about using Roth money to help buy a home (down payment). Do you have a source for reading about the 10,000 limit? I had thought he could withdraw all his contributions to make home purchase, but not his interest/dividends, without penalty. Pretty dismayed to think he can only access 10k and would appreciate some sources we can follow up on. Thanks
edit: I did a quick search and an article on SoFi and one in Forbes suggests you can withdraw all contributions for any reason, but there was a suggestion that the earnings up to 10,000 may also be withdrawn for first home purchase, but may be subject to income tax.
I think you may have misread -- Alan's statement about the $10k was in regard to the earnings, not contributions.

1) You can withdraw regular contributions without tax or penalty.
2) You can also withdraw earnings early but that would be subject to income tax and the additional 10% penalty/tax.
3) However, in the case of withdrawing earnings early for a first-time homebuyer, $10,000 of the earnings are not subject to the additional 10% penalty/tax.

References:
https://www.irs.gov/pub/irs-pdf/i5329.pdf - see section "Exceptions to the Additional Tax on Early Distributions", number 09.
https://www.bogleheads.org/wiki/Roth_IRA#Distributions
Yes, I had misread the initial statement, thinking that withdrawal of "qualified distributions up to 10k" included initial deposits, not just earnings. I know there is no penalty or tax due on the original contributions if withdrawn early for any reason, but are you also saying there is no income tax due on the first 10,000 of gain if withdrawn for 1st time home purchase? I thought gains if taken were taxed. Thank you for clarifying.
sycamore
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Re: Tax Question ROTH Principal Withdrawal

Post by sycamore »

capran wrote: Sat Dec 04, 2021 12:37 pm ...
Yes, I had misread the initial statement, thinking that withdrawal of "qualified distributions up to 10k" included initial deposits, not just earnings. I know there is no penalty or tax due on the original contributions if withdrawn early for any reason, but are you also saying there is no income tax due on the first 10,000 of gain if withdrawn for 1st time home purchase? I thought gains if taken were taxed. Thank you for clarifying.
You're correct about that. The exception I mentioned is in regard to the early withdrawal 10% penalty only. Any early withdrawals remain subject to income tax as you noted.
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Cloud
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Re: Tax Question ROTH Principal Withdrawal

Post by Cloud »

Thank you all for the replies. This is helpful.

I appears I have used the wrong terminology. The money withdrawn from the ROTH IRA all came from TIRA rollovers that happened more then 5 years ago. So I guess technically these should be called rollovers not principal contributions, but I don't see any tax treatment difference as long as the 5 year rule is met. Still zero tax due, correct?

Thanks,
Last edited by Cloud on Mon Dec 06, 2021 8:37 am, edited 2 times in total.
Gill
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Re: Tax Question ROTH (sic) Principal Withdrawal

Post by Gill »

Roth is not an acronym but rather the name of a US Senator. Just FYI. :happy
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Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal
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Re: Tax Question ROTH Principal Withdrawal

Post by retiredjg »

Cloud wrote: Mon Dec 06, 2021 8:07 am Thank you all for the replies. This is helpful.

I appears I have used the wrong terminology. The money withdrawn from the ROTH IRA all came from TIRA rollovers that happened more then 5 years ago. So I guess technically these should be called rollovers not principal contributions, but I don't see any tax treatment difference as long as the 5 year rule is met. Still zero tax due, correct?

Thanks,
The tax treatment is the same, but the paperwork is different. What you have are conversions and they are tracked on line 24, not line 22.

It seems you can do what you want to do, but you'll need to get your tax-software up to date on all the past contributions/conversions so that the software will know what the available basis is. There is a worksheet in the 8606 instructions for this if you want to look at what it will entail. I think if you fill that out by hand then getting the info into the tax software will be easier.
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Cloud
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Re: Tax Question ROTH Principal Withdrawal

Post by Cloud »

Thanks everyone. I think I'm all set now. Using FreeTaxUSA and after deleting the 1099-R and reentering it, it finally asked me all the appropriate questions about the basis. Zero tax owed!

Thanks again!
Alan S.
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Re: Tax Question ROTH Principal Withdrawal

Post by Alan S. »

capran wrote: Fri Dec 03, 2021 9:44 pm
Alan S. wrote: Fri Dec 03, 2021 11:24 am
Cloud wrote: Thu Dec 02, 2021 3:07 pm Early retiree and have been living on cash and investment savings for years now. Still not 59 1/2. This year we withdrew a substantial amount from our ROTH (return of principal and meets the 5 year rule) to purchase a second home.
FYI - the Roth 5 year period is immaterial in this situation, as there is no waiting period to withdraw regular Roth contributions tax and penalty free.

You may have read about the "first home" exception under which a first time homebuyer of a MAIN HOME can take qualified distributions from a Roth IRA up to 10,000 which can include tax free earnings. This does not apply to a second home, therefore you would not report any of this distribution on line 20 of Form 8606.
Alan, We have been discussing with adult child about using Roth money to help buy a home (down payment). Do you have a source for reading about the 10,000 limit? I had thought he could withdraw all his contributions to make home purchase, but not his interest/dividends, without penalty. Pretty dismayed to think he can only access 10k and would appreciate some sources we can follow up on. Thanks
edit: I did a quick search and an article on SoFi and one in Forbes suggests you can withdraw all contributions for any reason, but there was a suggestion that the earnings up to 10,000 may also be withdrawn for first home purchase, but may be subject to income tax.
The first home benefit for Roth IRAs is probably the most confusing aspect of reporting Roth distributions. If a taxpayer has enough Roth regular contribution or aged conversion basis to fund the purchase costs, the distributions will be tax and penalty free. The home purchaser does not need to tap any Roth IRA earnings, and would therefore not report an amount up to 10k on line 20 of Form 8606. There are no dollar limits to these distributions if you do not report on line 20.

Instead, consider a taxpayer whose Roth consists of 50k of regular contributions and aged conversions and 20k of gains, and the taxpayer needs 60k. The taxpayer has also held a Roth for at least 5 years. In this situation the taxpayer would enter 10k (the max allowed) on line 20. The 10k of gains is treated as a qualified Roth distribution tax and penalty free, as described in Pub 590 B, p 29. The other 50k follows the usual Roth IRA ordering rules and would also be tax and penalty free in this example.

Therefore, tapping up to 10k of gains is optional, and the 10k is a lifetime limit. As such you should not enter 10k on line 20 of Form 8606 if you do not need it as that would exhaust your limit with no benefit. Best to save that limit for the future.

Note that the 10k lifetime limit also applies to waiving the 10% penalty for early distributions, so if you use up the 10k by tapping conversions not yet aged for 5 years (Pub 590 B p 25), that will also eliminate the 10k for tax free distributions of earnings. The limit is 10k however you choose to utilize it. Different taxpayer situations call for different decisions. The IRS has made no effort to provide examples showing how all this works.

Final unstated little secret from the IRS:
If part of the reason you want to show your 10k on line 20 is just to withdraw that amount of unqualified gains tax free and preserve your line 22 basis in the process, you can forget that plan. Because that tax free 10k was distributed, the "Basis in Regular Roth Contributions" worksheet p 11 of the 8606 Inst will reduce your remaining basis even when the tax free gains were distributed. The end result is a tax free distribution of gains up to 10k in the year of the first home purchase, but the next NQ Roth distribution you take will result in your line 22 being 10k lower. Therefore, for future years, you have 10k less of basis and 10k more of gains. In essence, you borrowed your gains tax free, but they spring back going forward for your next distribution. All of this clears up once your entire Roth is qualified.
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