I need clarification on the 5 year rule. I took a Roth distribution which included the principal and interest earnings. The Roth IRA was opened in April 2017 and designated for the 2016 tax year, therefore I believe that the 5 year clock starts ticking on Jan1 2016 and the 5 year requirement has been met as of Jan 1 2021, and the interest is not taxable. Do I have this correct?
Thanks!
To be a "qualifying" distribution, you must meet both the age test and the 5 year test. If you are over age 59-1/2, then the entire distribution is tax-free because you meet the age and 5 year rules. However, if you are under age 59-1/2, then you will owe income tax plus a 10% early withdrawal penalty on the gains in the account.
What if there was enough contributions to the ROTH IRA account to "cover" the gains at the time of distribution?
Example:
Scenario 1
Total contributions: $1000
Total gains: $75
Total distribution: $800
No income tax or penalty applies regardless of age. IRS allows withdrawal up to $1000 (the total contributions in this case)
Scenario 2
Total contributions: $1000
Total gains: $75
Total distribution: $1075
Income tax on the $75 gain, and 10% penalty if less than 59.5 yrs. No income tax or 10% penalty on the $1000.
Scenario 3
Total contributions: $1000
Total loss: -$75
Total distribution: $925
No income tax or penalty applies regardless of age as the total distribution is less than the total contributed money.
Is my understanding correct?
Thank you
Yes, that is correct. You can withdraw contributions you made to your Roth IRA anytime, tax- and penalty-free.
You will need to make sure that you enter your prior year's net contributions when TurboTax asks about them in the follow-up questions: