Baker Law Firm, P.C.
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The basics of taxes and Roth IRAs

Like other Connecticut residents, you may be wondering how to fund your retirement. You may decide to participate in your employer's 401(k), which uses pre-tax dollars to fund. This means that you will owe taxes on withdrawals when you reach the qualified age. In addition, you could owe a penalty tax if you make early withdrawals.

Another option is to take out a Roth Individual Retirement Account. You fund this account with after-tax dollars, meaning that you already paid taxes on the contributions. This provides an advantage when you make withdrawals since they are generally tax-free. This may seem like a win-win scenario since you won't owe taxes on amounts you take out of the account during your retirement years, but in some situations, you could owe taxes.

When would withdrawals incur tax liability?

If you are under the impression that distributions from your Roth IRA would never incur tax liability, then you may want to consider the following scenarios:

  • The monies your Roth IRA earns could require you to pay taxes on any withdrawals if you have not had the account for at least five years.
  • If you are under the age of 59 1/2 when you remove earnings from the account, but have had it for at least five years, you could owe both a 10% penalty and income tax on the amount you take out. However, there are exceptions to this rule you may want to make yourself familiar with because, if the withdrawal falls under one of them, you may not owe the taxes.
  • If you are under the age of 59 1/2 and remove earnings from an account you have not had for at least five years, you could incur income tax and the 10% penalty tax.
  • If you are over the age of 59 1/2 and the account is not yet five years old, you could owe income tax on earnings withdrawals, but not the penalty tax. 

You need to know that these rules only apply to the amounts your Roth IRA earned, not your contributions, which the IRS treats differently for tax purposes. The same is true for rollover and conversion amounts you put into the account.

When would withdrawals not incur tax liability?

There are times when you can remove money from your Roth IRA without incurring any income or penalty tax liability:

  • You can withdraw the amount of your contributions even if you have yet to reach age 59 1/2.
  • Under certain circumstances, you may withdraw money from your Roth IRA if it is at least five years old, even if you have not yet reached age 59 1/2. If you inherited the account, you suffer from a disability or you meet one of the IRS exceptions, your distributions may not incur taxes.
  • If you are over the qualifying age and the account is at least five years old, withdrawals should not incur any tax liability.

Of course, this article only touches on the basics of taxation as it applies to a Roth IRA. In order to gain a full understanding of when your withdrawals may be taxable, it would be greatly beneficial to discuss your situation and needs with an experienced tax attorney. This is your money, and you deserve to keep as much of it as possible -- tax-free.

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