Roth IRA and Earnings?

[10can]

I know that the Roth IRA is funded with after tax dollars so you are suppose to be able to withdraw your contributions and earnings tax free correct?

Just so I can better understand let me use this example...

I contribute $2,000 into my self directed Roth IRA and I buy $2,000 dollars worth of Walmart stock selling at $50.00 per share giving me 40 shares.

6 months go by and I sell all 40 shares at $55.00 per share = $2,200

So I made $200. dollars and I can now withdraw that from my Roth and not pay any tax at all ( income tax, capital gains tax, etc... )???

Thank you

[humandraydel]

You can withdraw contributions at any time penalty free. However, the earnings are only tax free if withdrawn at retirement (age 59.5 I think). If you withdraw the earnings prior to that, it will be similar to a distribution from a traditional IRA - 10% penalty and income tax.

[10can]

So if you are 59 1/2 then your earnings do not count as income?

I also read that you can withdraw up to $10,000 in earnings for your first home purchase without penalty.

[noppenbd]

First we need to understand what a qualified distribution is. Qualified distributions from a Roth IRA are tax and penalty free (they do not count towards your AGI). In order to be a qualified distribution, the following two requirements must be met:

1) It must occur at least five years after the Roth IRA owner established and funded his/her first Roth IRA

AND

2) At least one of the following requirements must be met:

a) The Roth IRA holder must be at least age 59.5 when the distribution occurs OR
b) Distributed assets limited to $10,000 are used towards the purchase or rebuilding of a first home for the Roth IRA holder or a qualified family member OR
c) The distribution occurs after the Roth IRA holder becomes disabled OR
d) The assets are distributed to the beneficiary of the Roth IRA holder after his/her death.

So a distribution of $10K towards a first-time home purchase (or rebuilding of a first home) would be a qualified distribution as long as the account holder had opened a Roth (any Roth) at least 5 years ago.

As I read it, a distribution of more than $10K towards a FTHP would be partially qualified (tax and penalty free) and partially nonqualified (earnings subject to tax and penalties, contributions not subject to tax or penalties).

I'm not sure how the IRS determines which portion of the distribution is contributions and which is earnings. It is probably on a pro-rated basis though.

[MonkeyMama]

True - but since you put the money in post-tax you can always withdraw your straight contributions with no tax consequences, any time.

However, rollovers and all that are treated differently. Obviously the income is another story, and must meet the above requirements to be withdrawn tax-free. There are some other rules mixed in there.

10can - that is the whole point on ROTHs - The earnings are tax-free, if you wait to retirement to use the money. A great deal for young people, as ideally the money compounds for decades, tax-free.