One of the big reasons (aside from the tax advantages) that so many personal finance writers like the Roth IRA is due to the fact it is possible to withdraw money early from the account without penalty. It is true that you have to meet certain conditions in order to make a penalty-free withdrawal, but the option is still there. The temptation to withdraw from a Roth to fund a college education or put a down payment on a house is tempting, so it is important to make sure you are meeting the Roth IRA withdrawal rules. Otherwise, your Roth IRA could cost you.
Early Withdrawal Fees and Penalties
The age at which you can begin making withdrawals is 59.5. If you withdraw from your Roth IRA before them, without meeting one of the exceptions, it is going to cost you a 10% early withdrawal penalty. On top of that, you will have to pay taxes on your earnings if your withdrawal is non-qualified. This amount will be taxed at your income rate. Finally, your plan holder/manager might impose its own fee for early withdrawals. All of that starts to add up.
Of course, it is worth noting that you can withdraw your own contributions to your Roth IRA at any time. Withdrawing your original contributions is usually not a problem — unless your original contribution is part of a conversion from a Traditional IRA to a Roth IRA.
Roth IRA Conversions
One of the popular retirement planning moves lately has been converting to a Roth from a Traditional IRA. Last year, anyone could convert. That policy has been extended, and it is possible to continue converting a Traditional IRA to a Roth IRA. However, it is important to note that converting to a Roth IRA will cost you. Since Traditional IRA contributions are made before taxes, you will have to pay taxes on the conversion amount. Those who made the conversion in 2010 can spread out their tax payments over two years, but those making conversions starting in tax year 2011 will have to pay taxes the year of the conversion. The cost of taxes is an important consideration when deciding whether or not to convert.
It is also important to remember the five-year rule when considering the Roth IRA. If you don’t follow this rule, you could find yourself paying penalties for taking unqualified, early distributions. You are not to take distributions from the earnings (your original contribution is another matter) in your Roth IRA account until five years have passed. The good news is that the five years starts on January 1 of the year of your first Roth IRA contribution, so periodic contributions made later don’t start the clock over again.
If you convert, though, each conversion you make has its own five-year requirement. You have to have the assets sitting in the Roth IRA for five years, or until you turn 59.5 (whichever happens first). If you are older than 59.5 when you make the conversion from a Traditional IRA to a Roth IRA, you can access your original contribution at any time. The earnings, though, have to wait five years — or you are subject to a penalty.
Before withdrawing money from a Roth IRA, it is a good idea to consult with a tax professional or financial planning professional to get a better of idea of how you can avoid the costs related to a Roth IRA.
Have you ever made a withdrawal from your Roth IRA,and did you follow all the rules?
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