The order Roth IRA withdrawals are treated under IRS rules

Roth IRAs contain money from different sources: regular contributions, converted or rolled-over amounts, and investment earnings. When a distribution is not qualified, the IRS ordering rules determine which category is treated as withdrawn first. A client cannot choose to withdraw only the earnings or only a particular conversion lot for purposes of these federal rules.

The three distribution layers

1. Regular contributions. The total regular contributions are treated as distributed first.
2. Conversion and rollover contributions. These are treated as distributed next, on a first-in, first-out basis, generally starting with the earliest year. For each conversion, the taxable portion is treated as distributed before its nontaxable portion.
3. Earnings. Amounts above regular contributions and conversion or rollover contributions are treated as earnings and come out last.

Aggregate Roth IRAs for the ordering calculation

For this purpose, add distributions from all of the owner's Roth IRAs together and aggregate the relevant contribution groups. The ordering rule does not let someone take regular contributions from one Roth IRA while treating a withdrawal from another as coming first from earnings. The IRS publication also gives specific rules for rollovers, recharacterizations and excess-contribution corrections, which should be handled separately from an ordinary withdrawal.

Ordering and qualified-distribution tests answer different questions

A qualified Roth IRA distribution is generally tax-free when the account satisfies the five-year period and the distribution occurs after age 59½, because of disability or death, or for a qualifying first-home distribution subject to a lifetime limit. If a distribution is qualified, the ordering rules do not make the earnings taxable. For a nonqualified distribution, ordering identifies the source category; taxability and the 10% additional tax depend on the distribution rules and exceptions.

Conversion five-year periods are separate

A five-year period can apply separately to each conversion or rollover contribution when testing the 10% additional tax on certain early distributions of taxable converted amounts. This is distinct from the five-year period used to determine whether a Roth distribution is qualified. One clock does not replace the other. Use the year and taxability of each conversion when analyzing a scenario.

Example of the ordering

Suppose all Roth IRAs together have regular contributions, two prior conversions and earnings, and the owner takes a nonqualified withdrawal. The distribution first reduces the regular-contribution layer. After that is exhausted, it reaches the earliest conversion; within that conversion, the amount previously included in taxable income is treated as coming out before its nontaxable basis. Later conversion amounts follow in order, and earnings are last. The result is a tax classification, not a statement that the custodian must sell specific investments in that order.

Exam method

1. Determine whether the distribution is qualified.
2. If it is nonqualified, apply regular contributions first.
3. Then apply conversions and rollovers FIFO, taxable portion before nontaxable portion for each conversion.
4. Treat earnings as last in the ordering sequence.
5. Separately evaluate the applicable five-year rule, age requirement, taxability and additional-tax exceptions.

Key takeaway

Remember the sequence: regular contributions, conversion and rollover contributions FIFO (taxable portion first), then earnings. Apply qualification and penalty tests separately.

The ordering ladder

A nonqualified Roth IRA withdrawal is not automatically taxable from the first dollar. The IRS aggregates a taxpayer’s Roth IRAs and applies ordering rules. Distributions are treated first as regular contributions, then as conversion and rollover contributions on a first-in, first-out basis, and last as earnings. Within each conversion or rollover layer, the taxable portion is treated as distributed before the nontaxable portion. This ordering determines income inclusion and whether an early-distribution tax may apply.

Regular contributions generally come out tax-free because they were made with after-tax dollars. Conversion principal can also be nontaxable on withdrawal, but the taxable part of a conversion may face a separate five-year additional-tax rule if withdrawn early and no exception applies. Earnings are taxable if the distribution is not qualified, and the 10% additional tax may also apply to their taxable portion. These layers should not be collapsed into a single “Roth money” category.

Qualified Roth IRA distributions are generally tax-free if the five-tax-year period is met and the distribution occurs after age 59½, due to disability, after death to a beneficiary, or for a qualifying first-home purchase within its lifetime limit. The five-year period for a qualified distribution is not the same as the separate five-year period that can apply to each conversion for the early-distribution additional tax.

Worked example: contribution and conversion

Assume a 40-year-old has contributed $25,000 directly to Roth IRAs over several years and converted $30,000 from a traditional IRA, of which $20,000 was included in income at conversion and $10,000 represented basis. If the person withdraws $28,000 before age 59½ and the distribution is not otherwise qualified, the ordering rules treat the first $25,000 as regular contributions. The remaining $3,000 comes from the earliest conversion layer and is attributed first to its taxable component, subject to that conversion’s five-year rule.

If the client withdraws $60,000, the $25,000 contribution layer is exhausted, then $30,000 of conversion principal is treated as distributed, and the remaining $5,000 reaches earnings. The exact tax and penalty result depends on conversion dates, qualified-distribution status, exceptions, aggregation, and other contributions or rollovers. The example illustrates sequence only; a tax preparer should use Form 8606 and IRS Publication 590-B for an actual return.

A distribution from one Roth IRA is not tested in isolation if the owner has several Roth IRAs. The IRS ordering rules aggregate accounts for distribution analysis. However, rollover contributions from other Roth IRAs are disregarded in the ordering rule in the specified manner. Keep records of contributions, conversions, rollovers, and prior distributions across custodians, particularly after account consolidations.

Avoid the two five-year-rule mix-up

The qualified-distribution clock generally begins with the first tax year for which the owner made a contribution to any Roth IRA established for them. Once that clock is satisfied, a distribution still must meet a qualifying event to make earnings tax-free. A client under 59½ may have a qualified distribution after death or disability, for example, even though the client themselves is not taking a standard retirement withdrawal.

Each conversion or rollover can have a separate five-year period for determining whether an early withdrawal of its taxable conversion amount faces the additional tax. The period begins on the first day of the tax year of that conversion. A client with multiple conversions therefore may have different clocks. The additional tax rule is not a general lockup of the entire Roth account and does not make all conversion principal taxable.

For a CFP question, determine whether the prompt asks income-tax treatment, qualified-distribution status, or additional-tax treatment. Apply the ordering sequence first, then test the specific layer and clock. The common mistakes are treating earnings as withdrawn first, assuming every conversion has one shared clock, or confusing the five-year qualified-distribution test with conversion recapture.