Roth IRA Contributions and Earnings

Feb 01, 2023 By Susan Kelly

What is the rules about Roth IRA withdrawals? The regulations for withdrawing money from a Roth IRA change depending on whether the money comes from your contributions or investment earnings. It is important for you, as an investor, to understand what each term means:

  • The money you put into an individual retirement account (IRA) is called a contribution.
  • Your gains are equal to your earnings. Both are exempt from taxation inside your account.

The maximum contribution that may be contributed to a regular or Roth IRA in a given year is capped at $6,000 in 2022 and $6,500 the next year (2023). People 50 years old or older are eligible to make a catch-up contribution of up to $1,000 each year. This applies to both years.

Your contributions to your Roth IRA may be withdrawn at any time, for any reason, and you won't be subject to any taxes or penalties if you do so. Because the contributions are made using post-tax cash, you have already paid income taxes on the money you have contributed. Put another way, if you make a contribution and then withdraw it, it is treated in the same way as if you had never made the contribution.

The process for withdrawing from the earnings accrued in the account is different. Depending on your age and the time you've owned the account, you may be required to pay income taxes on these distributions in addition to a 10% penalty. You are permitted to take any earnings from your contributions once you have reached the age of 59 and one half and have kept the account for at least five years, as stated by the Internal Revenue Service (IRS). There are, of course, a few notable exceptions, which we will discuss in more detail below.

Roth IRA Income Limits

As was discussed, restrictions are placed on the total amount of money that may be contributed to a Roth IRA each year. However, if your annual income is within limits established by the Internal Revenue Service, you will not be eligible to contribute. This indicates that the amount of money you may put into a Roth IRA each year may be reduced or eliminated, depending on how much you bring in each year.

The following table provides information on the beginning and ending dates of the contribution phase-out. At the highest end of each income bracket, taxpayers will no longer be allowed to contribute to their Roth IRAs after completing the phase-out.

Roth IRA 5-Year Rule

In general, you are allowed to take your earnings without incurring any taxes or penalties if both of the following conditions are met:

  • You must be at least 59½ years old.
  • According to the so-called "five-year rule," it has been at least that long since you made your initial contribution to a Roth IRA.

No matter how old you were when you created the account, the five-year rule will still apply to you. For instance, if you are 58 years old when you make your first contribution, you will need to wait until you are 63 years old before you can take any money and avoid paying taxes.

The countdown begins on January 1, the year after which you made your first contribution to a Roth account. Your five years won't correspond to a complete five calendar years since you have until April 15 of the next tax year to make your contribution. For instance, if you made a contribution to your Roth IRA at the beginning of April 2020 but designated it for the 2019 tax year, you will only have to wait until January 1, 2024, provided that you are at least 59 and a half years old, to withdraw your earnings from your Roth IRA without having to pay taxes on them.

When converting traditional IRAs to Roth IRAs, the countdown clock begins on January 1, the year the conversion was completed. It is not when the account is inherited that the clock begins ticking on inherited Roth IRAs; rather, it begins when the original owner makes the first contribution to the account.

Roth IRA Qualified Distributions

It is not necessary to pay taxes or penalties on qualified distributions. If your Roth IRA account has been in existence for at least five years and the distribution fulfils both of the following criteria, the IRS will consider the payout to be qualified:

  • Made on or after the day when you turn 59½.
  • Because you have a permanent impairment.
  • After your passing, it will be made by a beneficiary or your estate.
  • A lifetime cap of $10,000 is placed on the amount used to purchase, construct, or remodel a first house.

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