Ryan O’Leary is a writer and former financial services professional. He writes about personal finance for Wealthsimple and his work has been featured by the New York Stock Exchange. Ryan holds a Bachelor's degree in International Business from University College Cork in Ireland.
A Roth IRA is a tax-advantaged individual retirement account. Unlike a traditional IRA, your contributions to a Roth IRA aren’t tax-deductible. However, those contributions and your investment earnings grow tax-free, so there’s no income tax on your Roth IRA withdrawals in retirement. With a traditional IRA, your withdrawals in retirement are taxed as income.
Like a traditional IRA, a Roth IRA is an account that holds your investments.
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Roth IRA Contribution Rules
In 2019 an individual can make an annual contribution of up to $6,000 to a Roth IRA. Individuals who are age 50 and older by the end of the year for which the contribution applies can make additional catch-up contributions (up to $1,000 in 2019); this is referred to as the “catch up contribution.” So an individual who is under age 50 may contribute up to $6,000 for the 2019 tax year, but an individual who reaches age 50 by year-end 2019 may contribute up to $7,000.
All regular Roth IRA contributions must be made in cash (which includes checks); regular Roth IRA contributions cannot be made in securities. However, a variety of investment options exist within a Roth IRA, once the funds are contributed, including mutual funds, stocks, bonds, ETFs and money market funds.
A Roth IRA can be funded from the following sources:
spousal IRA contributions
You can contribute to your Roth IRA up to tax day of the following year.
Roth IRA Withdrawal Rules
With Roth IRA withdrawals, there are two main things to remember:
You can withdraw the money you contributed to a Roth IRA at any time and for any reason without paying taxes or penalties. That’s because you already paid taxes on the money you used to fund the account
Different rules apply to withdrawing investment earnings. If you’re not careful, you may owe taxes and penalties.
If you’ve had your Roth IRA for 5 years or longer, you can avoid taxes and the 10% early withdrawal penalty on earnings if two things are true:
The account has been open for five years or more — the clock starts on Jan. 1 of the year you make your first contribution — and you meet at least one of the following conditions:
You’re age 59½ or older
You’ve become disabled, or you’ve died and money is being withdrawn by your estate or account beneficiary
The withdrawal (up to $10,000 lifetime maximum) is for a first-time home purchase.
If you’ve had your Roth IRA for less than 5 years, there are a few situations where you can avoid the 10% early withdrawal penalty on earnings, but you’ll still be subject to income taxes:
You’re age 59½ or older
The withdrawal is due to disability
The withdrawal is made by a beneficiary or your estate after your death
The money is for a first-time home purchase (as described in IRS Publication 590-B, Early Distributions, Exceptions section), certain medical or qualified education expenses
Due to financial hardship, you decide to start taking substantially equal periodic payments (called SEPP, a program described in this IRS FAQ), which requires committing to taking distributions for a certain period of time to avoid paying penalties.
You’re not required to start withdrawing money from your Roth IRA when you retire.
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Roth IRA Distribution Rules
The tax treatment of a Roth IRA distribution depends on whether the distribution is qualified. Qualified distributions from Roth IRAs are tax- and penalty-free, but non-qualified distributions could be subject to tax and/or the 10% early-distribution penalty.
For a distribution to be qualified, it must occur at least five years after the Roth IRA owner established and funded their first Roth IRA, and the distribution must occur under at least one of the following conditions:
The Roth IRA owner is at least age 59½ when the distribution occurs
The distributed assets are used toward the purchase, or to build or rebuild a first home for the Roth IRA owner or a qualified family member. Qualified family members include the IRA owner's spouse, a child of the IRA owner and/or of the IRA owner's spouse, a grandchild of the IRA owner and/or of their spouse, a parent or other ancestor of the IRA owner and/or of their spouse. This is limited to $10,000 per lifetime
The distribution occurs while the Roth IRA owner is disabled
The assets are distributed to the beneficiary of the Roth IRA owner after the Roth IRA owner's death.
A non-qualified distribution may be subject to income tax and/or the 10% early-distribution penalty. The source of a non-qualified distribution determines the applicable tax treatment. Roth IRA distributions can come from the following four sources:
regular Roth IRA contributions
taxable traditional IRA conversions and taxable rollovers from qualified plans, 403(b) or governmental 457(b) plans
nontaxable traditional IRA conversions and nontaxable rollovers from qualified plans and 403(b) plans
earnings on all Roth IRA assets.
The 10% early-distribution penalty doesn’t apply to certain amounts that aren’t subject to income tax. These include amounts that were contributed in excess of the contribution limit and are then removed from the Roth IRA before the Roth IRA owner's tax-filing deadline (plus tax-filing extensions).
Roth IRA Tax Rules
There are two key things to know about the tax treatment of Roth IRA funds:
Contributions to a Roth IRA aren’t tax deductible. This differs from a traditional IRA, where contributions may be deductible from your taxes in the year you make them.
Investments in a Roth IRA grow tax-free. That means you owe nothing in taxes on earnings when the money is in the account — or even when you withdraw it in retirement.
Investors also pay no taxes on earnings growth in a traditional IRA, as long as those funds stay in the account. But unlike a Roth IRA, you will eventually pay taxes on the earnings growth in a traditional IRA when the money is withdrawn.
Inherited Roth IRA Tax Rules
When you inherit a Roth IRA, you won’t pay income tax on your distributions, nor will the distributions count as taxable income when determining your tax bracket. However, if you elect to take the life expectancy method, distributions that fall below the required minimum distributions (RMDs) will still be subject to the 50% penalty.
The lack of required withdrawals means those who don’t need to dip into their Roth IRA funds can leave the money in the account and pass all of the money along to their heirs. Inherited Roth IRAs generally require beneficiaries to take minimum distributions if the beneficiary is not a spouse of the deceased.
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