How Money Comes OUT of a Roth IRA
Roth IRAs are among my favorite types of accounts. In fact, when I look at my own net worth statement, my eyes are always drawn to my Roth IRA first. Dollar for dollar, growth in a Roth account means more than any other account title, because as long as the IRS rules are followed, that dollar grows tax-free and comes out tax-free.
In addition to tax-efficiency, Roth IRAs can offer great flexibility, but it’ important to know the rules so that you don’t get unexpectedly burned. The owner of the account may access some of the money anytime without penalty, because there are specific Roth IRA distribution ordering rules. The first money out of a Roth IRA are it’s contributions. “Contributions” are the dollars that the account owner put into the account, meeting the income criteria to do so. Contributions may be accessed anytime, at any age, tax and penalty free. An easy way to remember this is to understand the logic that the contributions have already been taxed, because contributions to Roth IRAs are always made with after-tax dollars. Converted dollars come out next. Conversions are when a person takes money from their traditional IRA which was funded with pre-tax dollars, pays ordinary income tax on the amount of and in the year of the conversion, and then is able to deposit those dollars into their Roth IRA. Conversions must remain in the Roth IRA for at least five years before they can be accessed, regardless of age, and a separate five-year holding period applies to each conversion. The five-year rule prevents one from converting traditional IRA dollars to a Roth and then withdrawing from the Roth, avoiding distribution penalties that would have otherwise been associated with traditional retirement account withdrawals. Finally, earnings come out last. In order to avoid premature distribution penalties, earnings must come out after 59 ½ and you must wait at least five years after your first contribution to a Roth IRA.
Many people are seasoned and aware of how money can go into a Roth IRA. Equally as important is knowing the rules as to how money comes out of a Roth IRA.
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A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.