3 Issues With Extreme Couponing You Should Know About
You might think extreme couponing sounds like a great way to save money. Here's why it may not be.
Roth IRAs are a great tool for saving and investing for retirement. Unlike a 401(k), your contributions to a Roth IRA are after-tax, so you get to reap the benefits on the back end after your money has had a chance to grow and compound tax-free (whereas your tax benefits for traditional IRAs are on the front end with a chance for deductions).
That said, Roth IRAs also have noticeably different withdrawal rules from a 401(k) and traditional IRA. Here’s what you should know.
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1. Withdrawals of contributions aren’t taxed or penalized
Roth IRA withdrawal rules largely depend on the “type” of money you’re withdrawing. You can withdraw your contributions — but not earnings — at any time, for any reason, without facing taxes or penalties. This is because you’ve already paid income taxes on the money you contributed before putting it into your Roth IRA. Contributions are the money you deposited into the account, and earnings are the profits you’ve made from your investments.
When you withdraw money from your Roth IRA, it’s treated as coming in a specific order:
Personal contributions
Money converted from a 401(k) or traditional IRA
Earnings
Supposed you contribute $6,000 to a Roth IRA and it makes $4,000 in earnings, bringing the account value to $10,000. If you withdraw $8,000, $6,000 will be treated as contributions, and $2,000 will be treated as earnings.
2. How the five-year rule affects taxation on earnings
The earnings you make on your investments in your Roth IRA are subject to different withdrawal rules. If you want to withdraw earnings from your account without facing income taxes or an early withdrawal penalty, you must be at least 59 1/2 years old, and it must be at least five years since your first contribution into the account (regardless of your age). If you’re 70 years old and made your first contribution three years ago and withdraw earnings, you’ll owe taxes on that amount.
The five-year countdown begins on Jan. 1 of the year you made the first contributions. If you make the contribution on June 1, 2022, for example, you would have to wait until Jan. 1, 2027. You also have until April 15 to make contributions for the previous year, which could affect your timing. If your first contribution was March 1, 2022, for the tax year 2021, you’d have to wait until Jan. 1, 2026, for your five-year timer to be up.
3. How qualified and nonqualified distributions work
The IRS allows for some exceptions to the withdrawal rules, known as qualified distributions. Qualified distributions are tax-free and penalty-free once you’ve satisfied the five-year rule, regardless of your age.
Withdrawals meet the qualified distribution requirements if it’s:
Taken because of a permanent disability.
Made on or after the day you turned 59 1/2 years old.
Given to a beneficiary after your death.
Used to buy your first home ($10,000 is the maximum amount).
Nonqualified distributions don’t meet the above requirements, but there’s a chance you can take penalty-free withdrawals if the following situations apply:
It’s for unreimbursed medical expenses that are more than 17.5% of your adjusted gross income.
It’s for paying healthcare premiums after losing a job.
You’re using it for adoption or childbirth costs (up to $5,000).
It’s for disaster recovery.
You face an IRS levy.
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