After you retire, everything you withdraw from a Roth IRA will be tax-free. This includes all the earnings you accumulated over the years. In exchange, the Internal Revenue Service wants you to have the account for at least five years and wait until you reach age 59 1/2 before you withdraw earnings. If you take earnings out early, the IRS gets so upset they'll hit you with a 10 percent penalty on top of ordinary taxes. However, the IRS is a lot more easygoing if you take contributions out early.
You can contribute up to $5,000 annually to a Roth IRA as long as you earn as much as you contribute. When you reach age 50, the limit increases to $6,000. Roth contributions are not deductible, which makes them after-tax dollars. Since you’ve already paid income taxes on contributed money, you can withdraw it at any time with no tax liability and no penalties. Penalties apply only to rollover funds and earnings withdrawn early.
Since one dollar looks pretty much like the next, you need a way to determine when money you take out of a Roth is considered "contributed funds." For guidance, use the IRS ordering rules for Roth withdrawals. Add up all of the contributions you made to the Roth IRA. As long as your total withdrawals are less than the total contributions, the withdrawals are contributed funds. According to the ordering rules, rollover dollars come next and then earnings.
Rollovers versus Contributions
You can't avoid paying taxes on money rolled over from a tax-deferred account such as a 401(k) or traditional IRA into a Roth IRA. This converts the pre-tax dollars into after-tax dollars. Although the rollover money consists entirely of after-tax dollars like your Roth contributions, you can't withdraw them early without penalty. The IRS does not classify a rollover as a contribution. In fact, rollover funds must stay in the Roth for at least five years.
If you make an excess contribution, you can always withdraw it without penalty. In fact, you’ll be penalized 6 percent of the excess amount each year until you do. You have until the due date to file your tax return, including extensions, to take out excess contributions.