Roth IRA accounts provide tax advantages designed to help investors save for retirement. In particular, your investment in a Roth IRA enjoys tax-free growth. When you withdraw earnings from the account, it does not qualify as income and you do not have to pay federal or state income taxes on those earnings as long as you limit withdrawals to qualified distributions.
The key to enjoying the tax advantages of a Roth IRA is limiting any withdrawals to qualified distributions. You can withdraw earnings from your account without tax impact if you are at least 59 1/2 years old and you established your account at least five years prior to the withdrawal. You also can make tax-free withdrawals if you are disabled, you are the beneficiary of a Roth IRA owner who has died or you are using the earnings to pay for the purchase or construction of a first home.
Unqualified withdrawals from the earnings portion of your Roth IRA will trigger tax consequences. The money withdrawn will count as income and qualify for income taxes. In addition, you also will be charged a 10 percent tax penalty on the income. However, you can withdraw money from the contribution portion of your account without paying income taxes on the funds. That money is considered your principal instead of new income. Money that you withdraw from a Roth IRA is considered to first come from the contributions until they run out. Additional withdrawals are taken from earnings.
Some additional withdrawals may be made from a Roth IRA without triggering the penalty tax, even though they still count as taxable income. Examples of exceptions include the withdrawal of funds for payment of qualified college expenses for you, your spouse or your children; medical expenses that are not reimbursed by insurance if the costs exceed 7.5 percent of your adjusted gross income; and medical insurance premiums if you are unemployed.
Contrast with Traditional IRA
Traditional IRAs offer tax benefits on the front end and Roth IRAs offer benefits on the back end. Contributions to a traditional IRA are tax-deductible. You may not deduct contributions to a Roth IRA. The trade-off is that while you must pay income taxes on distributions from a traditional IRA, distributions from a Roth IRA are tax-free.