Liquidating A Roth

You may have to pay tax penalties if you raid your retirement nest egg.

You may have to pay tax penalties if you raid your retirement nest egg.

The money that you deposit into a Roth IRA grows tax deferred. You can liquidate your Roth and avoid paying taxes and penalties if your withdrawal meets certain IRS guidelines. Depending on the situation, liquidating your account may lead to a hefty state and federal tax bill.

Principal

Roth IRAs are funded with after-tax rather than pre-tax money. You don't have to pay state or federal income tax on the same sum of money twice, which means you can withdraw any amount, up to the total amount of your own contributions, tax- and penalty-free at any time. Therefore, if your Roth IRA either loses value or remains steady in value, you can liquidate the account without having to mail a check to the tax man. By contrast, any earnings in your Roth account are potentially taxable.

Five-Year Rule

Earnings in your Roth IRA are subject to a five-year seasoning rule. You pay a 10 percent tax penalty and ordinary income tax on any withdrawals of earnings that you make within five years of first funding the Roth. Under federal tax laws, you can convert pre-tax retirement accounts such as IRAs or 401ks into Roths. When you do this, you pay tax on your contributions at the time of conversion and your future earnings are subject to the five-year rule.

Qualified Withdrawals

You avoid taxes and penalties when liquidating your Roth if you've held the funds for five years and make the withdrawal in connection with certain qualifying events. If you reach the age of 59 1/2 or become disabled you avoid the penalties. You also avoid the taxes and penalties if you make a withdrawal as a pay-on-death beneficiary on someone else's account. The Internal Revenue Service allows you to make a once-in-a-lifetime $10,000, tax free withdrawal from a Roth if you need the cash to buy a first home. Finally, you can avoid paying the tax penalties if you liquidate your Roth and convert it into a pension-style income stream with payments structured to last for the duration of your life.

Penalties

Aside from income tax and tax penalties, you may have to pay penalty fees to your account custodian when you liquidate your Roth. If you hold the money in a certificate of deposit or annuity, you may have to pay early surrender penalties that could eat up both the interest and some of the principal. If your account holds securities, you may have to pay trade fees and redemption penalties for selling shares, stock and bonds. You can often avoid these fees if you hold the securities for a particular period of time. Consult the plan custodian about time lines and fees before you cash in the account: you can't reverse a liquidation.

 

Resources

Photo Credits

  • Stockbyte/Stockbyte/Getty Images