ROTH: what if your contributions are invested?

[NoCoinsPlease]

Hi all:

Great site - this is my first posting so please excuse me if it's a dumb one. I did search for this but couldn't find it anywhere. I have a friend who has accumulated some debt but has a substantial ROTH account. I recommended she withdraw some of her ROTH contributions to pay the debt - it would only be about 15% of the total value of the ROTH account. That said, all of the money she has in the ROTH is invested in positions at this point (no cash). If she sells a position, are any special steps necessary to distinguish that she's withdrawing contributions vs. profit?

To make it easy, she needs $4000. She invested her 2006 $4000 contribution in stock ABC immediately in 2006. Her position in ABC is now worth $4500. Can she simply sell $4000 worth and withdraw that tax free (the $500 being profit?)? Does she need to liquidate the entire position for some reason? Or are any other steps necessary?

Thanks very much!
No Coins Please

[kv968]

Welcome and no that isn't a stupid question.

Your friend can cash out any amount she's contributed without paying taxes or a penalty. If she cashed out any gains she's made she'll have to pay taxes and a 10% penalty on those earnings.

If I may ask a question...How bad is your friend's debt that you think she should cash out her retirement savings to pay for it? Even though it's only 15% of her total account, she'll never be able to put that money back in there. I'd have her think long and hard about paying that debt off some other way and leave cashing in anything in her Roth as the very last option.

[NoCoinsPlease]

Your friend can cash out any amount she's contributed without paying taxes or a penalty. If she cashed out any gains she's made she'll have to pay taxes and a 10% penalty on those earnings.

This is where my confusion arises, though. If she put $4000 into stock ABC and that investment is now worth $4500, how much does she need to sell? If she sold $4000 and withdrew that as her contribution, theoretically the entire $500 still in the account is profit, right? But those individual shares of ABC aren't pure profit - does that matter. Is it as though she sold all of it and then bought back the ABC with the $500 in profit?

How bad is your friend's debt that you think she should cash out her retirement savings to pay for it? Even though it's only 15% of her total account, she'll never be able to put that money back in there.

She has credit card debt with a 25% apr. We've looked into a wide variety of other options (balance transfer, HELOC, etc.) and none will work. Also, I don't think she will be maxing out contributions to the ROTH again for at least another three years (she has additional debt as well), so it's not really a hinderance that she will be losing the opportunity to put the money in. If anyone has suggestions on other avenues to pay that debt off, we'd love to hear them.

[humandraydel]

Originally Posted by NoCoinsPlease

Is it as though she sold all of it and then bought back the ABC with the $500 in profit?

Basically. The bottom line is the government doesn't get any taxes from transactions inside a Roth, so they don't really care what you do. It's pointless to make you actually go through the act of selling everything and buying with the $500 profit.

I really wish they'd change the rules of an after tax 401k contribution withdraw to be more in line with the Roth.

[kv968]

Originally Posted by NoCoinsPlease

This is where my confusion arises, though. If she put $4000 into stock ABC and that investment is now worth $4500, how much does she need to sell? If she sold $4000 and withdrew that as her contribution, theoretically the entire $500 still in the account is profit, right? But those individual shares of ABC aren't pure profit - does that matter. Is it as though she sold all of it and then bought back the ABC with the $500 in profit?

She would only sell up to the amount she contributed and leave the rest (earnings) in there as stock. To use your example...she put $4000 into stock and now it's worth $4500. Say she bought the shares at $100/share which means she has 40 shares. Those shares go up in value to $112.50/share which gives her a total of $4500 ($112.50 * 40 shares). She would have to sell 35.5 shares to get her original $4000 back and leave the other 4.5 shares in there as earnings. Granted you can't do a half a share, but that's the math. I hope I didn't confuse things even more for you.

[usnavy_233]

I’ll try to add a tad of clarity to this as well.

The way the ROTH distribution works is that when you take money out, no matter how much you take or how much you have in, it's looked at as such:

1st contribution distributions

2nd qualified distributions

3nd non-qualified distributions

For simplicities sake, I'll give an example. Say your friend has put in 10K over the last 3 years and has earned 5K over the same time frame. She has a total of 15K in the account.

If she was to take 12K out, she would owe NOTHING on the first 10K she withdrawals, and the other 2K would be subject to taxes and penalties unless it is a qualified distribution. Now, if she only took out 8K, all 8K would be tax and penalty free. There is no “well this 3K was from earnings and this 2K was from dividends, etc” It’s a first come first serve basis. And the first served in a withdrawal is your contribution amount, then everything else.

Does that help?