If you are one among many Americans who are holders of Roth IRA accounts, it would be good news for you to know that you do not have to report Roth IRA withdrawals as earnings on your tax return for the current year (provided that your distributions are "qualified distributions").
This rule on Roth IRA taxes, i.e. Roth IRA withdrawals that are not "qualifying distributions", comes with certain exemptions that may not be very well known. Since these exemptions are not widespread, the owners of Roth IRAs should know when to apply them.
The first (and most common) exemption occurs when Roth IRA withdrawals are taken after age 59½, and the earnings within the account are included in the distribution. Additionally, 5 years must have passed since the initial contribution into the Roth IRA account. If both of the conditions are met, then the withdrawal is a qualified distribution and exempt from tax.
Say, for example that you contribute $ 4,000 into your Roth IRA every year, for four years. By that time, the account is able to generate an additional $4,000, making a total of $20,000 as the balance in the account. If you take out your entire account balance at a single time, being 59 ½ years or older, the $4,000 earnings will be subject to tax as regular income (the original contributions are not subject to tax). If you assume that the tax bracket is 30%, the Roth IRA taxes taxes will be $1,200. If you wait for one more year to make your Roth IRA withdrawal, those earnings will be tax-free.
In addition to the potential payment of Roth IRA taxes as explained above, an additional early withdrawal penalty of 10% will apply to any Roth IRA withdrawals taken before the age of 59 ½, the same as with a traditional IRA.
The earnings are liable to tax for almost all the rest of exceptions to the early withdrawal Roth IRA penalty, such as disability or demise. Actually there are no exceptions to the five year guideline, despite your age or any other reason for the withdrawal. The built-in table lists the rules of Roth IRA taxes on withdrawals.
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