Roth IRA Trading Rules

Investing money in assets that can increase in value is one of the best ways to build wealth and provide a good life for your family during retirement. You may open a Roth individual retirement account at financial institutions, brokerage companies and mutual fund companies. Roth IRAs offer tax benefits that make them attractive to investors who want to trade stocks frequently.

Roth IRA Basics

You and your spouse each may contribute up to $5,000 annually -- $6,000 for individuals age 50 or over -- to a Roth IRA if your adjusted gross income is less than $169,000 and you are filing jointly. The same limits apply to qualifying widows or widowers. Unlike 401(k) and traditional IRA contributions, Roth IRA contributions are made with after-tax income. In other words, Roth IRA contributions are not tax-deductible. On the other hand, you don't have to pay taxes on investment gains and withdrawals made after you retire.

Trading Investments Within a Roth IRA

Since a Roth IRA offers tax-free growth, you may freely trade investments within a Roth IRA without incurring the capital gains taxes that usually apply to investment profits. For example, if you open a Roth IRA with a mutual fund company and your investment grows from $5,000 to $5,500 during the first few months, you may shift your investments around within the account without paying capital gains tax on the $500 profit.

Drawbacks of Roth IRA Trading

The tax benefits of a Roth IRA can make it tempting to actively trade investments within an account to make tax-free profit, but actively trading Roth IRA funds carries several drawbacks. The stock market is unpredictable, and attempting to time the market through active trading can result in significant losses in a short period of time. Because IRA contributions have annual caps, you may not replace lost funds in your account if you have already reached the annual limit. In addition, investment losses in a Roth IRA may only be taken as a tax deduction when you withdraw the funds from the account, and the IRS places limitations on withdrawals.

Roth IRA Withdrawal Rules

While you may trade investments freely within a Roth IRA, withdrawals are subject to several tax rules. You may withdraw your contributions at any time, but you must wait five years before withdrawing investment gains without penalty. If you are under the age of 59 1/2, investment gains you withdraw from a Roth IRA are subject to a 10 percent early withdrawal penalty unless the withdrawal is for a qualifying reason. Qualifying reasons include buying a first home and becoming disabled.

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