Unless you are independently wealthy, saving for your retirement years is not optional. But faced with an uncertain economy, you might be a little uncomfortable putting your money into a traditional individual retirement account and risk big tax penalties if you have to take your money out early. A Roth IRA might be a better option. If you need to access money you contributed for the current year, you can cancel that contribution without a tax penalty.
Withdrawal of Contributions
When you contribute to a traditional IRA, you typically make that contribution with pre-tax dollars so you can take a tax deduction for that amount. Not so with a Roth IRA. You can only use after-tax dollars to contribute to your Roth account. Since you've already paid taxes on that money, you can withdraw an amount equal to your total contributions without paying any additional taxes or penalties. You don't even have to report the withdrawal to the IRS, although you should keep records just in case. Any earnings produced by your investments in your Roth IRA must remain in the account until they become qualified to avoid taxes and penalties.
Withdrawal By Due Date
If you withdraw the amount you've contributed to your Roth IRA by the due date for filing your taxes, the IRS will treat the contribution as if it never happened. Typically this means that you have until April 15 of the following year to cancel your contributions. If your contributions earned any income while they were in your Roth account, you can withdraw those funds too. You'll have to pay ordinary income taxes on the growth, but you won't owe a tax penalty.
You can only make contributions to your Roth IRA up to your original tax filing due date, typically April 15 for the previous year's taxes. But if you have a tax filing extension you can cancel your Roth IRA contributions for the year through the extended due date. If you withdraw any earnings produced by that year's contribution, you must report them as income for the year you made the contribution.
The IRS may not charge an early withdrawal penalty if you cancel your Roth IRA contribution for the year, but that doesn't mean you are completely off the hook. All Roth IRAs are, by law, custodial or trust accounts. Your account custodian or trustee might charge transaction fees, and the financial product you invested your contribution in might impose an early withdrawal penalty. For example, a certificate of deposit might charge three months' worth of interest for cashing it in early. Your Roth IRA investments might also lose money. For example, if you invested your contribution in a mutual fund, the net asset value of its shares may have dropped.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.