If I Buy Stock for My Roth IRA, Do I Pay Taxes on Dividends?

Even if stocks in your Roth IRA generate more dividends than you ever imagined, the money isn't taxable as long as the dividends stay in the account. In most cases, it won't be taxable when you withdraw your money, either, but there are exceptions. Under some circumstances the IRS will expect a cut of your withdrawals.

Qualified Distribution

As long as you take what the IRS calls qualified distributions, your earnings are tax-free. To qualify, you must wait five years after you first deposit money in the account, and you must be at least 59 1/2 years old. Qualified distributions include those taken as the result of becoming disabled, those taken to buy a first home, and those made to your beneficiary after you die. If your distribution isn't qualified, you pay tax on the earnings.

Early Withdrawals

Like a traditional IRA, if you take money out of your Roth before you turn 59 1/2, the IRS can hit you with a 10 percent tax penalty for early withdrawal on top of regular income tax. The big difference is all withdrawals from a traditional account are taxed; with a Roth, only the withdrawal of earnings is taxed. The IRS allows several exceptions for emergencies, such as major medical bills or college expenses.

Ordering Rules

If you make an unqualified withdrawal, you don't have to decide whether to withdraw from earnings or contributions. The IRS rule is that all your withdrawals come from contributions until you exhaust them. If you have any conversions or rollover money in the account, those dollars go next. Only after all your contributions are exhausted will withdrawals be taken from earnings. If you have taxable withdrawals, you calculate the amount on IRS Form 8606.

Losses

There's always the risk that instead of delivering dividends, your stocks will tank and your Roth will wind up losing money. You can write off the loss, but not until you empty out your account and show that your withdrawals are less than you originally contributed. To take the deduction, you must itemize your loss as a "2 percent deduction" on Schedule A. Add it to any other 2 percent deductions you have, such as unreimbursed employee expenses, and subtract 2 percent of your adjusted gross income. Whatever remains is your write-off.

About the Author

Author of two film reference books, "Cyborgs, Santa Claus and Satan" and "The Wizard of Oz Catalog." Published in Air & Space, Backpacker, Newsweek, The Writer, and multiple trade journals (can fax samples if requested, don't have them available digitally)