Roth IRA Contributions versus Roth Investment Gains
I have some friends at work that don’t understand what I believe are some very important aspects of a Roth IRA. Some I’m going to identify an overlooked aspect of Roth Ira because of the unusual word “Contributions”.
Yes we all know the definition of the word contribution, but it’s still a little foggy how it relates to Roth IRAs. To keep this discussion simple and because it’s the most common type of contributions, I’m only going to talk about “Direct Contributions”
So what is a direct Contribution?
These are contributions that you deposit into a Roth IRA from the earnings in your checking/savings account, and other already taxed income. These type of contributions are NOT from rolling money from another IRA into it (if it were a transfer from another IRA, then it would be called a Rollover contribution)!
So think of direct Contributions as money that you deposit in your Roth IRA from the money you made from your job, in other words, your earned income…
The money portion of your direct Contribution into a Roth IRA can be withdrawn at any time both tax and penalty free! It’s tax-free because it has already been taxed! And it’s penalty free because with your contributions, there is nothing to penalize.
Here is an example to make it more clear:
Let’s pretend that MR has contributed $5,000 to a Roth IRA for each of the last 3 years. He now has an emergency and need to tap into the Roth IRA, which is currently valued at, oh let’s say $20,000!
So three years of $5,000 means the total direct contributions comes to a total of $15,000 but since there is $20,000 in the Roth IRA, that would mean that the investment gains portion would be $5,000.
So if I had an emergency after 3 years, I can take out the $15,000 amount that I contributed to the account and do whatever I want with it. However, if I try to take out the remaining $5,000 that is left; well that $5,000 would be taxes and my current income tax rate, and an early withdrawal penalty would apply!
I hope this example clears it up, if not please free to email me asking more, or leave a comment asking your question!
Tell me what you think of this great saving/investment vehicle?
-MR
One caveat! After 60 days, you can’t put your contributions back into the Roth IRA account. While this is a bit of a bummer, it’s still an incredible investment instrument!
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Great info MR! Personally, I did not realize the exact tax rules for the Roth IRA, and this explained it perfectly!
Thanks, this advantage of a Roth IRA isn’t talked about much. I think it’s because nobody want us to know that we can take the contributions out because it’s better to leave it in so it can grow. But I’d rather know… 🙂
I think the Roth IRA is the greatest thing since sliced bread. After maxing out your 401k just to the company match level, the Roth IRA is the next place to start saving money.
I agree! I also like the probate avoiding features of a Roth IRA too
Yup, love the Roth..too bad there are income limits on contributions. I wonder why they do that. Oh yeah, taxing the rich.
Yeah, not much fairness to it is there!
Luckily, if you have a small business there are alternatives retirement plans that are pretty good too. Eventually, I’ll blog about them also…
Not too unhappy though… I converted all my old trad IRAs into Roth IRAs during the 2010 conversion thingy, and I can put 16.5K annually into a Roth 403(b) (and another 12K into a regular 403(b) and another 16.5K into a tax advantaged state account) .
We high income folk aren’t being hurt too badly. Let the hoi peloi have their little tax advantaged 5K options. I’d rather have my 6K employer match and enormous tax deferred retirement accounts.
I was thinking SEP IRA, but that you talk about works too.
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I knew the rule that you can only take out the contributions, but I had no idea you could put them back within 60 days! Awesome! I always thought that once you “borrowed” from your Roth IRA, you couldn’t put it back at all. Yay! Good to know!
Yeah, but if you miss the 60 day windows, the IRS doesn’t cut you any slack. It seems they really don’t like that it’s possible to do this manuveur! It really wasn’t intended as a short term loan, but it can be… That’s why you don’t hear about it much!
Thanks for covering this. We were discussing this in comments on an earlier post, so it’s nice how you laid it out here…very accessible! I definitely see how you are using the Roth as a tool. I agree with your earlier comment that people don’t cover this aspect of the Roth as much because they want us to leave these accounts alone.
Yeah, I don’t like talking about it either really. But, since it’s something that I might do, I thought I should come clean on the option 🙂
The thing to remember is if someone is thinking about following such a path to make sure the rules haven’t changed! Normally, they don’t but nothing is set in stone with the government…