Most individuals who own a Roth IRA are aware that the account must be open for a certain number of years before earnings can be withdrawn without penalty. Many Roth IRA owners may assume that the same rule applies to funds rolled over into the account. In fact, rollovers to a Roth IRA are subject to slightly different requirements than regular contributions are.
The regulations imposed on IRA withdrawals are intended to discourage the early use of retirement funds. If applicable, the penalty on an early IRA distribution is equal to 10 percent of the nonqualified withdrawal. To avoid the penalty, Roth IRA owners should be aware of the differing rules for rollovers and regular contributions.
Regular contributions to a Roth IRA
Like most types of retirement accounts, the accumulated earnings in a Roth IRA may be available when you reach age 59 1/2. Because Roth contributions are post-tax, there is no further income tax when your contribution is returned. The advantage of a Roth IRA is that the earnings are also received tax-free.
A unique aspect of a Roth IRA is that the account must be open for a 5-year period before the owner can withdraw earnings without a penalty. Even if you are over age 59 1/2, a Roth IRA must have been established for five years in order to withdraw earnings tax-free. The 5-year rule is fairly straightforward for regular contributions, but the rule applies differently to a Roth IRA funded by a rollover.
Rollover contributions to a Roth IRA
Regardless of your age, any funds rolled over into a Roth IRA must remain in the account for a 5-year period in order to withdraw the funds without penalty. Although there is no income tax on a Roth IRA distribution, the 10 percent penalty can potentially apply to both the earnings and the amount that was rolled over.
The 5-year requirement applies separately to each rollover to a Roth IRA. Therefore, you may have multiple 5-year periods to keep track of if your Roth IRA has received more than one rollover contribution.
Roth IRA ordering rules
If you make a withdrawal from a Roth IRA, the funds are considered by the IRS to be distributed in accordance with a set of ordering rules. Regular contributions are received first. Rollovers are considered to be received next. Each rollover is considered separately, on a first-in, first-out basis. If withdrawn, rollover contributions that fail to meet the 5-year requirement are subject to the penalty.
You will likely need to file IRS Form 8606 with your income tax return to report a rollover to a Roth IRA. Contact a financial advisor for more information on IRA rollover strategies.Contact a financial service, like Harwood Financial Group , for more help.Share