Q:

How are Roth IRA distributions taxed?

A:

Quick Answer

An investor can withdraw his Roth IRA contributions at any time without tax or penalty. To withdraw earnings or interest the Roth IRA earns without paying taxes, he must be at least 59 1/2 and the Roth IRA must be at least 5 years old.

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Full Answer

The IRS imposes a 10 percent penalty on Roth IRA earnings and interest withdrawn within five years of an investor's initial contribution. The five years start on January 1 of the tax year in which an investor opens the account. The IRS resets the five years on converted Roth IRAs, making day one the first day of the tax year in which the Roth IRA was converted.

The IRS imposes a similar 10 percent penalty on earnings and interest withdrawn after this five-year period but before the investor turns 59 1/2. Some exceptions include withdrawing earnings and interest to use for purchasing a first home, in the event the investor becomes disabled, or withdrawals made to an investor's beneficiary or estate after his death. The IRS still imposes the 10 percent penalty if the funds are withdrawn for one of these reasons within five years of opening the Roth IRA.

The IRS requires an investor to include early withdrawals as part of his taxable income for the tax year he withdrew the earnings and interest. Depending on his tax bracket, the IRS may tax an investor's early withdrawal by up to 40 percent. Including an early withdrawal as income may also put him into a higher tax bracket, increasing his overall tax liability for the year.

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