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The money portion of your direct Contribution into a Roth IRA can be withdrawn at any time both tax and penalty free!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!