A Roth Individual Retirement Account (IRA) is funded with after-tax dollars. You don't get a tax deduction for your contributions, as you generally would with a traditional IRA. If you make a qualifying distribution, you can take money out of your Roth IRA tax-free. Otherwise, you can still take money out of your account, but you may be liable for taxes and penalties.
The first step in qualifying for a tax-free Roth distribution is to satisfy the five-year rule. The IRS requires your withdrawal to occur after your Roth has been established for at least five years. The five-year period begins at the start of the taxable year in which you first contributed money to a Roth in your name. For example, if you contributed $1,000 to your Roth in June 2006, your qualifying distribution would have to be taken after the beginning of 2011.
You can't qualify for a tax-free distribution from your Roth until you have reached age 59 1/2. Otherwise, your withdrawal is considered premature. Not only will you have to pay tax on some of your withdrawal, you'll also owe the IRS an additional 10 percent as an early distribution penalty.
Withdrawal of Contributions
If you can't make a qualifying distribution, you may still be able to take at least some money out of your IRA tax-free. Since contributions to a Roth IRA are always made on an after-tax basis, you don't have to pay tax when you withdraw them. According to the IRS ordering rules for distributions, your contributions come out first. If you have contributed $10,000 to a Roth that is now worth $15,000, the first $10,000 that you withdraw from the account will come out tax-free. You'll still owe the 10 percent early distribution penalty if you take out money before age 59 1/2, however.
You can rollover your Roth IRA to another Roth IRA at any time without triggering any tax consequences. You can even take a physical distribution from a Roth IRA, keep it for up to 60 days and replace it in your Roth IRA without any tax consequences. If you fail to return the money within 60 days, the rollover will be classified as a distribution. However, if you satisfy the five-year rule and the age requirement, even that distribution will not be taxable.
- Jupiterimages/liquidlibrary/Getty Images