Investing your savings in a Roth IRA rather than another type of retirement account generally allows you access to more of your money sooner in life, without paying taxes or penalties. Your withdrawals might trigger a tax or a penalty under some circumstances, however. Some simple rules can help you determine whether your Roth IRA distributions will be tax-free or not. Show
Key Takeaways
Are Roth IRA Distributions Tax-Free?Your withdrawal from a Roth IRA isn't taxable under three circumstances:
NoteRoth IRA contributions are made with after-tax dollars. You can't take a tax deduction for them at the time you make them. Therefore, you can withdraw your contributions at any time without paying tax again. When Are Roth IRA Distributions Taxable?Your Roth IRA distributions might be taxable if:
NoteThese rules apply only to earnings, which aren't treated the same as contributions or conversion amounts. Example No. 1Suppose Sally is 58, and she opens her first Roth with a contribution of $6,000. She also converts $50,000 from a traditional IRA to this Roth IRA. Sally reaches age 60 with a Roth IRA worth $60,000 two years later. She cashes it all in to buy a motorhome. Sally pays no tax on her $6,000 in contributions, and she pays no income tax or the 10% penalty tax on her $50,000 from conversions because she already paid tax at the time she converted. She has no penalty because she is over age 59 1/2. She only pays income tax on the $4,000 that is attributable to earnings because she hasn't met the five-year rule. NoteNone of the distribution would have been taxable if the account owner had taken out only the amount of original contribution and conversion funds. The earnings could be left for another few years, when the owner could have withdrawn those funds tax-free. Example No. 2John is 58, and he's had a Roth IRA for more than five years, with a balance of $20,000. His original contributions totaled $10,000, and last year, he converted $8,000 from a traditional IRA to his Roth. Another $2,000 of his Roth is from investment gains. John cashes in his entire Roth IRA. John pays no tax on the first $10,000 of his distribution because he's withdrawing his original contributions. He pays a 10% penalty tax on the next $8,000 of his distribution because it's been less than five years since the conversion. He pays income tax and a 10% penalty tax on the last $2,000 of distribution, which is all investment gains, because he doesn't meet the dual requirements of the five-year rule and, being over age 59 1/2, and he doesn't qualify for any exemptions. He would pay no tax on this portion of the distribution if he were over age 59 1/2. He would pay income tax, but not a penalty, on this portion of the distribution if he were over age 59 1/2 but hadn't met the five-year requirement. Conversions vs. EarningsYour distributions are deemed to occur in a specific order when you take them from a Roth IRA, depending on whether they're contributions, conversions, or earnings. NoteThis order of distributions is intended to keep people younger than age 59 1/2 from taking a regular IRA, converting it to a Roth, then taking a distribution the next year, thereby circumventing the traditional IRA early-withdrawal penalty. Regular contributions are distributed first. These come out tax-free, regardless of age or the length of time that's passed since you opened the Roth. Conversion and rollover amounts are distributed on a first-in, first-out basis. The taxable portion that you would have been required to include in gross income at the time of the conversion is distributed first. The non-taxable portions of conversion/rollover amounts are next. Conversion or rollover amounts that are subsequently distributed can be subject to the 10% penalty. A five-year clock begins running when you convert funds to a Roth, and any amounts that you had to include in income at the time of the conversion and that are withdrawn before the five-year period is up are subject to the 10% penalty. This penalty does not apply to distributions from Roth conversions that occur after age 59 1/2. NoteRoth 401(k)s, called "designated Roth accounts," work a little differently. Not all of these rules would apply if you have money in a Roth 401(k) at work. The Bottom LineLike any retirement account, it's important to do your best to keep the money invested as long as you can. The longer your money can stay invested and grow, the better off you will be. Talk to a financial planner first to see how it will impact your future if you plan to use your retirement funds for a major purchase. Frequently Asked Questions (FAQs)Do Roth IRA distributions count as income?As long as you are qualified, your Roth IRA distributions will not count as income. To qualify, you must be over the age of 59 1/2 and the account must have been open for at least five years, although there are some exceptions. How much are distributions from a Roth IRA taxed?When you withdraw from a Roth IRA before the account is five years old and/or you are below the age of 59 1/2, you may be required to pay a 10% penalty fee and regular income taxes on the amount. Do I have to pay state taxes on a Roth IRA withdrawal?If you've met the five-year holding requirement, you can withdraw money from a Roth IRA with no taxes or penalties. Remember that unlike a Traditional IRA, with a Roth IRA there are no Required Minimum Distributions.
Do you pay federal and state taxes on Roth IRA?Roth IRAs allow you to pay taxes on money going into your account and then all future withdrawals are tax-free. Roth IRA contributions aren't taxed because the contributions you make to them are usually made with after-tax money, and you can't deduct them.
Do you pay state tax on IRA distributions?When you withdraw money from your IRA or employer-sponsored retirement plan, your state may require you to have income tax withheld from your distribution. Your withholding is a pre-payment of your state income tax that serves as a credit toward your current-year state income tax liability.
Are Roth IRA distributions subject to income tax?Generally, they still do not count as income—unless the withdrawal is considered a non-qualified distribution. In that case, the earnings could be taxable. (The IRS website, IRS.gov, explains what defines qualified vs. non-qualified Roth IRA distributions.)
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