By now you should know that the Roth IRA is a pretty important component to any healthy financial plan for a young adult.
Now it’s time to learn the basic rules for the Roth IRA. I’ve pulled the most important points together so you won’t spend time on what you don’t need to know. But if for some reason, you want all of the Roth IRA rules, check out IRS Publication 590.
How Much Can I Contribute to My Roth IRA?
1) If contributions are made only to Roth IRAs, your contribution limit generally is the lesser of $5,500 ($6,500 if you are age 50 or older), or your taxable compensation.
The contribution limits have the potential to change each year. In the last few years they have not changed, but you should double check if they have changed each year the new IRS rules are released.
When Can I Contribute to My Roth IRA?
2) You can make contributions to a Roth IRA for a year at any time during the year or by the due date of your return for that year.
If you are contributing for the year 2014, you can contribute for 2014 even into April of 2015 when tax returns are due. This is a great way to catch up if you missed the opportunity to contribute.
What if I Want to Contribute More to My Roth IRA?
3) A 6% excise tax applies to any excess contribution to a Roth IRA.
Double check your contributions before the tax year ends. Request a withdrawal for any extra contributions you’ve made in order to avoid the excess contribution penalty.
Can I Change My Mind and Open a Roth IRA if I Already Have a Traditional IRA?
4) You can convert a traditional IRA to a Roth IRA. The conversion is treated as a rollover, regardless of the conversion method used.
In order to convert, you will have to pay taxes on the balance of the Traditional IRA. Those are ‘before-tax’ dollars and they have to be changed into ‘after-tax’ dollars.
The IRS will handle that little bit of magic for you.
When Can I Withdraw from My Roth IRA?
5) You can withdraw, tax free, all or part of the assets from one Roth IRA if you contribute them within 60 days to another Roth IRA.
How Much Can I Withdraw from My Roth IRA?
6) Direct contributions to a Roth IRA (principal) may be withdrawn tax and penalty free at any time.
You are free to withdraw your contributions at any time. Even if you just opened your account last year or two years ago. No special forms needed. Just don’t withdraw earnings. Then the tax man cometh.
Is There a Way I Can Withdraw Roth IRA Earnings Penalty Free?
7) If you withdraw contributions (including any net earnings on the contributions) by the due date of your return for the year in which you made the contribution, the contributions are treated as if you never made them.
If you withdraw contributions and earnings typically you are taxed, but if you take them in the same year you contributed, then it’s like the contributions never happened!
When Can I Withdraw All of My Money From My Roth IRA?
8) Generally, if you are under age 59½, you must pay a 10% additional tax on the distribution of any assets (money or other property) from your Roth IRA. Distributions before you are age 59½ are called early distributions.
Are There Any Exceptions? What if I Want to Buy My First Home?
8b) You may not have to pay the 10% additional tax if you are in one of the following situations.
- You have reached age 59½.
- You are totally and permanently disabled.
- You are the beneficiary of a deceased IRA owner.
- You use the distribution to buy, build, or rebuild a first home.
- The distributions are part of a series of substantially equal payments.
- You have unreimbursed medical expenses that are more than 10% of your adjusted gross income (defined earlier) for the year.
- You are paying medical insurance premiums during a period of unemployment.
- The distributions are not more than your qualified higher education expenses.
- The distribution is due to an IRS levy of the qualified plan.
- The distribution is a qualified reservist distribution.
How Long Can I Keep My Roth Account?
9) You are not required to take distributions from your Roth IRA at any age.
Want to leave your money in the account? You can do that. This rule works pretty nicely when you purchase an investment property inside of a Roth IRA.
What Happens to My Individual Retirement Account When I Die?
10) A beneficiary can combine an inherited Roth IRA with another Roth IRA maintained by the beneficiary only if the beneficiary either inherited the other Roth IRA from the same decedent, or was the spouse of the decedent and the sole beneficiary of the Roth IRA and elects to treat it as his or her own IRA.
Married and your spouse passes away? You can combine both Roth IRA accounts into one for the surviving spouse. A Roth IRA can also be passed down to a child as an inheritance. Now that’s how to begin building generational wealth.
And now you know the basics of the Roth IRA. Have you fallen in love yet?
Anything else you know or like about the Roth IRA?
This post is a part of a special Roth IRA series. See the other posts and videos by clicking over to The Ultimate Roth IRA Guide for Young Adults.