Upcoming expenses and low investment returns may leave you wondering whether you should cash in your Roth IRA and deposit the funds in a savings account or certificate of deposit. Legally, you can transfers funds from a Roth to a non-retirement savings account at any time. However, depending on your circumstances, a Roth withdrawal may greatly increase your tax bill.
You do not receive a tax break when you invest in a Roth because your funds are contributed on an after-tax basis. However, your account grows on a tax-deferred basis, which means that you only pay taxes on your earnings when you make a withdrawal from your Roth. Unlike other types of retirement accounts, the IRS allows Roth owners to keep their earnings within these tax-deferred accounts for life. Simply put, if you never make a withdrawal, you never pay a penny of income tax on your earnings.
As the name implies, Roth IRAs are designed to provide you with money for your retirement years. While you do have to pay taxes on your earnings, you can withdraw your principal at any time without paying any taxes. Additionally, Roths have a seasoning requirement, which means that you pay a 10 percent tax penalty on withdrawals of earnings that you make within five years of establishing the account and prior to reaching the age of 59 1/2. Depending on your tax bracket, you could lose 30 percent or more of your earnings if you transfer money from your Roth to a regular savings or CD account.
Regardless of your age and the time you have held your account, you can avoid the tax penalty if you use Roth money towards the purchase of a first time home. The IRS imposes a lifetime cap of $10,000 on such penalty-free withdrawals. You can also avoid the penalty if you return to college and use the money to fund certain eligible educational expenses. If you become disabled or have unreimbursed medical expenses, you can also make penalty-free Roth withdrawals. You must provide the IRS with evidence of these expenses when you file your taxes. You cannot just transfer money to your savings on the basis that you may buy a house or return to college at some point in the future.
Some people mistakenly think of Roth IRAs as a bank or investment products, while in fact, the term, Roth IRA, is simply used to segregate tax-deferred savings from other taxable accounts. With some exceptions, you can use Roth funds to invest in the same types of accounts that you can buy with non-retirement money. If you are unhappy with the performance of your Roth, you can move your money to a CD or savings without having to pay any taxes or penalties. You can ask your bank to create a Roth account for you, and then open a CD or savings account within that holding account.