 Hello and welcome to the session in which we will discuss individual retirement accounts or IRA. Specifically, we're going to be discussing the IRA distribution. Now what is an IRA? An IRA is a personal saving account. So what is a personal saving? It's an account that's in your name. It's personal. It has nothing to do with your company. That's why it's called individual retirement account. It accumulates money set aside by the taxpayer for retirement. So what is a special about IRA? Well, it's a vehicle to save for your retirement. We have two types of IRAs. We have traditional IRA and a Roth IRA. So first we are going to learn about the contribution into an IRA. So you might be asking yourself, why do I want to learn about the contribution if I am being discussing the distribution? Here's why. If you know how the contribution works for an IRA, it's much easier to understand the distribution. Actually, once you understand it, you don't have to remember it. So IRA is a personal investment account. Let's assume you open an account for yourself, an IRA account, and you're going to put money in that account. You're going to put money every year in that account, whatever is allowed. You're going to put this money and you're going to invest this money in stocks. You're going to invest money in bonds. You're going to invest this money in gold, whatever you want to invest this money in. You're just basically making investments. You're taking this money and making investment. Now you might be asking, what's special about this? Well, the first thing that's special about this, if it's a traditional IRA, you can have the money taken out deductible. Simply put, every year, for example, you want to put away $5,000 into your IRA. So what's special about this $5,000? This $5,000 would reduce your taxable income. It's deductible. It gave you a tax break now. It gave you a tax break. So if you're in the 30% tax bracket, let me just show you what happened right now, times 0.3, you just saved yourself, saved on your taxes 1,500 if you are in the 30% tax bracket. This is the benefit of it. So you got a tax bracket now and you can withdraw it later. And remember, this money is earning earnings for you, earning interest, earning dividend, earning capital appreciation, so on and so forth. So the contribution to a traditional IRA may be deductible or the contribution may not be deductible. May not be deductible means you don't get a tax break. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. Now why would you choose one over the other? We'll talk about that later. Now that's one, this is the traditional IRA. Also we could have a Roth IRA. The Roth IRA is all the contribution that you make, so if you open a Roth IRA, so this is Roth, you open a Roth IRA account and you contribute it again $5,000. No tax break, hold on a second. So why would I put my money in a Roth IRA if I can get a tax break for my regular IRA? I think you may not qualify for a regular IRA and even if you qualify for a regular IRA or traditional IRA, there are some benefit to the Roth IRA. Now what is the benefit? Well, since you did not get a tax break when you put the money in, when you take it out, as long as you meet certain requirement, everything is tax-free and this is the benefit. Well, the regular IRA, when you take the money out, if that money, you get a tax break on it, when you put it in, everything is taxable, everything is taxable as ordinary income. That's not only taxable, it's taxable as ordinary income. Well, but some of it is capital gains on tax, on stocks and bonds. It does not really matter. The IRS is waiting for you to take this money out. They've been waiting for so long and now it's time to tax you. So this is the overall idea, the big idea. So for a traditional IRA, if the amount contributed was the taxable, for tax purposes, the distribution is fully taxable and this should make sense. You did not pay taxes going in, you have to pay taxes going out on both principal and earning and that's ordinary income. If the contribution were not deducted, because you don't qualify and we'll talk about that later, because we're going to have a separate session about IRA contribution when it comes to the contribution, which could be part of your adjustments. If the contribution was not deducted, then the principal amount is return of capital. When you take it out, the principal portion is not taxable because you pay taxes already on that part. Taxpayer investing in a traditional IRA are required to take a minimum distribution referred to as RMD by April 1st of the first year of the taxpayer reaches the age of 72. And why did I add this statement here to remind you that you put your money in a traditional IRA and that's deductible? At some point, the government's going to force you to take it out because they want you to take it out. They want to tax you. So they have what's called this required minimum distribution because at some point you may not need this money. You know, when you reach 72, you might be rich. He's like, I'm going to keep it. I don't want to pay taxes on it. Well, the government, well, gave you a break, put it in, but they want you to take it out. So they tax you on it. So there is a minimum distribution. Now, contribution made to a Roth. Now, we're dealing with a different IRA. Now, you might be asking first, why it's called the Roth IRA? It's the individual that sponsored the law called Roth. So they called it Roth IRA. Those contribution, when you put your money into a Roth IRA, I told you it's not deductible. If the Roth IRA meets certain requirement, we'll discuss later then the distribution is 100% tax-free. So this is the benefit of the Roth IRA. You don't get a tax break now. It grows. You take it out. It's all tax-free, which is great. Now, also you need to know that a Roth IRA don't require a minimum distribution. Why? Because the government don't care about it. Actually, they want you to keep it. They don't care about it. Why? Because you already paid your taxes. Paid your taxes on that money when you put it in. This is the 1099R where the IRA distribution is being reported. So they'll give you the gross distribution, how much it was distributed, what's the taxable amount, if they withhold any money from your taxes. If there's any distribution code here, why the distribution was made, because sometimes there's a penalty, if there's an exception, so on and so forth. As a taxpayer, you will have two parts. Part of the IRA could be tax-free. It's reported here and part could be taxable. Now, I blocked out the years because once you see the year, people get nervous and say, this is maybe an old lecture. It doesn't matter. The idea is the same. The form might change a little, but the idea is the same. Now, let's talk about distribution out of traditional. What is traditional? Again, the traditional, the money could be in tax-free. The money may not be in tax-free. The contribution to traditional may be either deductible or not deductible. It's your choice. I mean, obviously, if you wanna take an advantage of the contribution now, you want it to be deductible, to save on your taxes. Once the contribution are deducted, then the principal amount taxable when received, and obviously, of course, the principal as well as the earnings, the principal plus the earnings. Why? Because you didn't pay any taxes on the earnings yet and the principal was going in tax-free. On the other hand, when the contribution are not deductible, so when you contributed this $5,000 and you did not take advantage of that, well, the principal amount, when you take out the money, there's a principal component. That component is not taxable because you already paid taxes. It was not deducted. Now, distribution of earnings from all IRAs is taxable, whether it's deductible or not deductible. The earnings is in addition to the principal. They are taxable when received. Now, it's important to know that distribution from non-deductible IRA are prorated between principal and earnings based on the relative amount available in the account at the time of the distribution. Don't worry, we'll look at an example. Distribution out of Roth IRA. Now, remember, Roth IRA, the money that you contributed initially was what? Was not tax deductible. So you did not get a tax break on it. So the distribution are never taxable as long as you meet the requirement because you already paid taxes on that. On the other hand, distribution of earnings are taxable unless, remember, if you meet the requirement of a Roth IRA, everything is tax-free. The distribution takes place after five years from the first day of the year in which the first contribution to the Roth was made by the taxpayer. Simply put, if you kept that money for five years, from the first day of the year in which the first contribution to the Roth IRA was made, you met the five year requirement and you met one of the following conditions. You are 59.5 years old. So you have to start this account around, you know, early in 55, right? So to meet the five years and start to take it out at 59.5 or the taxpayer is using the contribution, 10,000 of it. You're limited to 10,000 to buy a first home. The taxpayer is disabled. The recipient of the distribution is a bit beneficiary. Simply put, the owner of the Roth IRA passed away. In contrast to traditional IRAs, distribution from Roth comes out of principle first. Then the remaining is considered early. And we'll look at an example. So when you take money out of the Roth IRA, but remember, you have to keep it five years to be tax-free. That's the first condition. You have to keep it five years. Then meet any of these conditions for it to be tax-free 100%. But if you took it earlier, well, we consider that you're taking the principle out and we'll see an example. Let's start with an IRA example. At the age of 55, Ray opened a traditional IRA. He contributed 4,500 and deducted the full amount from his gross income. So Ray got a tax break when they put that money in. Let me just, let's assume Ray is in the 25% tax bracket. If we take 4,500 times 0.25, so Ray saved under taxes $1,125 when they contributed this money. Three years later, Ray withdrew the total accumulated amount of 6,200 and used it to acquire a personal car. Well, guess what? Because you put that money and you got a tax break on it, the full amount that you take out is taxable as ordinary income. The total amount, the 6,200, which is fully taxable, 4,500 of the principle, 1,500 of the gain, all of it is taxable. Now, if you took it prematurely, it means you don't qualify to take it out. You're also gonna be subject to a penalty. And we'll talk about the penalty in a separate session. Now, assume the contribution was not deducted was made. So now Ray contributed the 4,500, but did not get a tax break. So contributed the 4,500 and let it go. Ray withdrew 5,500 for personal use, determine the taxable amount. Since the amount was not tax deductible, now we have to prorate it. What we do is we'll take the amount withdrawal divided by the value of the account and simply put, you withdrew 88.7% of the account. Well, you compute the earnings, which is 1,700, because the earnings is the taxable component, which is how did we get to 1,700? Well, Ray contributed 4,500 and the value is 4,000, contributed 4,500 and the value is 6,200. The gain is 1,700 and we're gonna take the 1,700 multiplied by 88.7. So we considered the of the 1,700, 88.7 is withdrawn, therefore 1,337 is taxable. Let's take a look at an example with a Roth IRA. At age 55, Ray opened a Roth IRA, contributed 4,500. I added here not deductible to remind you, it's not deductible by its nature. Four years later, uh-oh, not good, why? Because you have to wait at least five years. Ray withdrew the $6,000 from the total accumulated amount of 100,000. Now this Roth grew to 100,000, but Ray only took 6,000. How much of that amount is taxable? Well, remember, in the Roth IRA, we assume the principal is taken out first. So Roth took out 6, not Roth, Ray took out 6,000. 4,500 is tax-free, which is a return of capital because Ray contributed this money and the 1,500 is taxable as earnings. Principal, assume Ray withdrew the full amount six years later to buy a boat. We're gonna assume also, Matt, one of the qualification, he's now 50, you know, he's six years later, he's over 1,500 and a half. How much of it is taxable? Now see what's gonna happen now. None, none is taxable, why? Think about it, Ray only invested 4,500, really maybe played the cryptocurrency and get out on time. This money grew to 100,000. That's a lot of money, that's a lot of capital gains, that's a lot of earnings. Guess what? Because he waited more than five years and met all the other requirement. None of that amount is taxable, zero is taxable. Zero is taxable. Okay, remember, six years and now after six years, he's over 59 and a half, so he met the age requirement. What happened if you have an early withdrawal from an IRA? In other words, take the money out prematurely. Well, distribution from an IRA before reaching 59.5 are subject to a 10% penalty unless the distribution was used to acquire a first time home buyer, a home, which is take out 10,000. You are allowed to do that. Just like from your 401K, you're allowed to take out the 10,000 and you have to pay the home, buy for home within 120 days, buy medical insurance, basically necessity, cover medical expenses and access of adjusted gross income floor of 7.5%. Pay expenses associated with a permanent disability. Notice how all those are emergencies. Pay for education, that's not an emergency, but they allow you to do that. Cover up to 5,000 of adoption or birth expenses. In this case, the distribution should be made within one year from the date of the adoption or birth and cover the tax payer debt. Now, it's also worth noting that the penalty represent in addition to your regular income tax. So you have to pay your taxes, then you have to pay a penalty. Real story, I have two friends who liquidated their IRA without even knowing the tax consequences. They called me, I was still in practice and I was like, I received this letter from the IRS and I have a large tax bill, can you take a look at it? I was like, okay, send it to me and look at the letter and there was an IRA distribution. They took it out, they were moving, they needed the money, they spend it on personal stuff items, then they get the penalty, 10%, then they get to pay taxes and they were not aware of that. So just be careful when it comes to the IRA. Now, at some point, not at some point, we're gonna have another session that deals with contribution because the contribution is an adjustment, it's a deduction and we'll talk about that later. What should you do now? Go to far hat lectures, look at additional MCQs through false multiple choice that's gonna help you understand this topic better. Good luck, study hard, whether you are a CPA candidate or an enrolled agent, invest in your career, invest in yourself and stay safe.