The major advantage of the Roth IRA is qualified distributions are TAX FREE. Investment earnings are not just tax deferred, as with a traditional IRA, but are tax free. One more time… TAX FREE!
That’s what makes financial planning and retirement planning so dang important for those of you in your 30’s and 40’s. I mean right now you’ve got to be thinking about getting with this program if you haven’t done so already. The Roth IRA will be the single most important move you make towards securing your financial future. Period.
Those that have been contributing to Roth IRA’s and have converted regular IRA’s are licking their chops. If you do the right things now, put together a solid asset allocation and give your Roth account room to breathe and grow, you will be sitting on a large asset that’s completely TAX FREE! TAX FREE!
Qualified Distribution
In order for a distribution or withdrawal from your Roth IRA to be TAX FREE it has to be qualified. For distributions to be qualified, they must not be made until five years after the Roth IRA is set up. In addition to the five year test, a qualified distribution must be made for one of the following reasons:
- the owner reaches age 59 1/2
- the death of the owner
- the disability of the owner
- first time home buyer expense up to $10,000
The mandatory lifetime distributions required with a regular IRA do not apply to the Roth IRA, so you don’t have to begin (paying taxes on the money you are forced to take out) at age 70 1/2. Mandatory distribution rules do not apply to the Roth IRA until the individual’s death.
A person who has had a regular IRA his entire adult life just turned 70 1/2 and has to take his first RMD (required minimum distribution). What’s a good place for someone who is still working to put their money?
That’s right, a Roth IRA . Because at the time of death, the Roth IRA will pass tax free to their heirs. Keep in mind that the person still has to have earned income to do so and make at lease the amount to contribute the max ($6,000 for 2009).
Non-qualified Distribution
Lets say for whatever reason you need the money before any of the qualified requirements are met. Sometimes life comes at you fast and you unexpectedly need to take money out of your Roth IRA… it happens. This type of distribution is non-qualified.
Non-qualified withdrawals are subject to income tax and a 10% penalty for premature distribution… and should only be done as a last option. The amount in excess of your original contributions will be includible in your gross income for that year and an additional 10% penalty will be assessed on the distribution amount above the original contribution amount.
(These same penalties apply for traditional IRA’s, except in traditional IRA’s the entire distribution amount is taxed and penalized.)
Please remember there are no penalties or taxes for withdrawing the amount you originally contributed to a Roth IRA… that money can be withdrawn at any time with no consequence, because those were your after tax dollars to begin with.
The overwhelming majority of all Roth IRA distributions are qualified. If you are in a desperate situation and need to take an unqualified distribution from a Roth IRA (or a regular IRA for that matter) then chances are you’ve got bigger problems than premature distribution penalties.
So in summary… qualified distributions good, non qualified distributions bad…
