New IRS regulation benefiting Roth IRA holders

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Earlier this month, the IRS issued final regulations to address distributions from Designated Roth Accounts (or DRAs) to other retirement vehicles. Effective May 18, 2016 (courtesy of TD 9769), a participant may allocate the earnings to the portion of a DRA directly rolled over into another eligible DRA or a Roth IRA, thereby minimizing the amount that would be taxable if the portion rolled over isn’t a qualified distribution.

So if you hold both a Designated Roth Account and a Roth IRA, you can now transfer post-tax savings from your DRA to Roth IRA more easily.

The IRS’s final regulations allow eligible participants to allocate after-tax and pre-tax amounts that are simultaneously disbursed from a Roth retirement plan to multiple destinations without requiring pro rata tax treatment. This eliminates the requirement that each disbursement from the Designated Roth Account that is directly rolled over to an eligible retirement plan is treated as a separate distribution from any amount paid directly to the employee.

Now, if such disbursements take place (i.e. to the employee as well as a Roth IRA or other DRA), then pre-tax amounts will be allocated first to the direct rollover rather than allocated pro rata to each destination. A taxpayer will be able to direct the allocation of pre-tax and after-tax disbursement amounts to multiple destinations. This minimizes the amount that would be taxable if the portion not rolled over isn’t a qualified distribution. A qualified distribution is one that is made at least five years after the year of the first designated Roth contribution and after the participant turns age 59 ½ or has a disability.

Let’s say you have $20,000 ($17,000 in post-tax contributions and $3,000 in earnings) in a DRA you wish to disperse to another Designated Roth Account. You can distribute the $17,000 in already-taxed Roth contributions to a DRA and directly roll over the taxable earnings into either another DRA or a Roth IRA without incurring taxes on those funds (the $3,000 should be allocated as earnings on IRS Form 8606.)

The final regulations apply to distributions from DRAs made on or after January 1, 2016. Individuals must follow the allocation rules when performing such distributions. In particular, allocations of any non-taxable funds should be in a dollar amount instead of a percentage. For more on the allocation rules, read Notice 2014-54.

If this is something you’d like to pursue further, consult with your tax advisor about your options regarding distributions from Designated Roth Accounts. And if you’d like to open a Roth IRA, open an account online today with Kingdom Trust to get started!