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Opening a Roth IRA for retirement savings is designed to provide you with significant tax benefits. The IRS regulates the taxcode and specific legislation has been written about tax requirements for Roth IRA owners. Those new to a Roth IRA can be easily confused about what types of taxes to pay, how much and when to file. If you have recently rolled over your IRA into a Roth, you will learn when to pay taxes on a Roth IRA and avoid penalties or potential account closure from disqualified account activities.
Differences Between Roth IRA and Traditional IRA Taxation
A traditional IRA account allows the contributions that you make during each year to be deducted from your gross income. This offers you an immediate tax break for each year that you own your account and make regular contributions. When you abide by the IRA rules of distribution, you will not be penalized for withdrawing funds from your traditional IRA.
A Roth IRA is slightly different and often considered to be a much easier retirement account to control each year. The contributions that you make from your employer-sponsored account come from after tax dollars. This means that your employer already withholds local, city, state, federal and social security taxes before contributions go into your Roth IRA. The contributions have already been taxed for the current year. Unlike a traditional IRA, your Roth IRA contributions cannot be deducted from your annual income each taxable year.
Roth IRA: A Tax-Free Account
If you follow the IRS rules, your account can grow tax-free for the entire term of ownership. Your funds can be invested into acceptable securities or other investments that you qualify for under the current Roth IRA rules. The tax-free savings continue when you make qualified distributions from your account. Unlike a traditional IRA, there is no mandatory distribution age for a Roth IRA.
When You Pay Taxes on Your Roth IRA
There are some instances when you could be required to pay taxes on a Roth IRA. Knowing what to avoid if you can help it will decrease or eliminate any taxes payable on your account.
Types of taxable scenarios:
• Rollover from an IRA to Roth IRA within the Taxable Year
• Rollover from Employee-Sponsored IRA into a Roth IRA
• Early Distributions
If your account is more than five years old and you are age 59½, you generally qualify for distributions and can avoid a ten percent tax penalty. If your distributions are not qualified, you are subject to a tax penalty on the funds that are distributed from your account. This could add up to a substantial amount if you withdrawal cash to make investments, purchases or other scenarios that involve cash. If you are considering a large distribution of cash, you might find it helpful to speak with an accountant or financial professional that can explain how to avoid tax assessments and penalties levied on unqualified Roth IRA distributions.