5 Year Wait to Withdraw from Roth – #1 REVISED

It is my understanding that one cannot withdraw money from a Roth IRA tax free until that money has been in for 5 years. If withdrawn earlier, any appreciation will be taxed – as from a traditional IRA. Consider a Roth with a single mutual fund, opened with $10K. FOUR years later, an additional $10K are added. After another THREE years a withdrawal of $15K is made. Over all the previous 7 years, the fund has “appreciated” in the normal fits and starts – no simple “8% a year” steady rate. How is the tax liability calculated?



Until the Roth holder reaches age 59.5 AND has met the 5 year holding period, all distributions are considered non qualified (with a couple special exceptions).

For a non qualified distribution, the Roth “ordering rules” apply. First out are the regular contributions tax and penalty free, then conversions starting with the oldest and these are tax free, but have a 10% penalty until they are held 5 years. The earnings come out LAST, after all these other contributions and will be subject to both tax and penalty.

The appreciation you cite is therefore not an issue until the entire contributed amount has been withdrawn. This is totally different from a traditional IRA which does not have ordering rules.

In your example, since 20,000 has been contributed and the 15,000 is apparently the first withdrawal, the entire distribution is tax and penalty free (assuming regular and no conversion contributions). Only after the 20,000 has come out would the earnings be tapped, and the amount of earnings can fluctuate between -0- and infinity at any given point in time.

Therefore, in order to be able to properly report such a distribution on Form 8606, good records must be kept because the form requires the amount of contributions to be entered since the first year of the Roth. Conversions must also be entered, if any. The 8606 will generate the taxable amount, if any, but it would be -0- in your particular example.



There is no 5 year wait to withdraw Roth IRA contributions. Contributions can be withdrawn tax and penalty free at any time.The ordering rules for withdrawals consider contributions as withdrawn first before any earnings. For this purpose all Roth accounts are aggregated and considered a single account. In your example the 15K is considered all coming from contributions and therefore tax and penalty free. If a Roth has been established for at least 5 years by contribution or conversion, and if at least age 591/2, then all distributions including earnings are qualified and tax and penalty free.



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