Is there any way to avoid taxes on a Roth IRA if you plan to retire early?

Question

I read somewhere that you can withdraw yearly equal amounts from the Roth without tax. Is that true and is that what they do so you can retire early?

Ok, I must not have been too clear. I know exactly what a Roth Individual Retirement Arrangement IS, and how it works. What I'm wondering is if they have a provision for early retirement. I'm assuming they don't since I can't find information about it. I just with I could use this vehicle for investing for an early retirement.

Answer 1

http://www.irs.gov/taxtopics/tc557.html

Check out that link. Basically, it states that if you set it up as "made as part of a series of substantially equal periodic payments over your life or life expectancy, " you can avoid the 10% tax penalty.

I would speak with your financial advisor/tax accountant to discuss ways to set it up this way.

Answer 2

In a way, you can use a Roth for early retirement....if you do it right.

The money you contribute to the Roth, because it has already been taxed, can be withdrawn at ANY time for ANY reason without causing your taxable income to go up or triggering any penalties. The "gains" must be left untouched until the year in which you reach 59 1/2. So, for example, if you fund the retirement with $40,000 ($4,000 per year for 10 years), and it has grown to $90,000, you could withdraw $40,000 before 59 1/2, withdraw the remainder after 59 1/2 and no tax or penalties would be assessed. If you must pull out gains before 59 1/2, it will be included in your taxable income and will trigger the 10% penalty. You can waive the penalty for the same reasons a Traditional IRA waives it (medical, education, death, disability, etc.). Unless you plan on dieing before turning 59 1/2, you will need some retirement to draw from after 59 1/2, so it sounds like the Roth may not be so bad after all. It is certainly better than just investing it in a regular account and paying taxes on the gains each year. At least you get to defer the taxation on the gains until you will most likely be in a lower tax bracket.

Answer 3

Distributions fro a Roth prior to age 59 and one/half are subject to tax and penalty. The rule also states that the first distributions come out of your annual contribution amounts before you get to income. Distributions of the amount invested is not subject to tax or penalty.
Therefore, if you can plan it right you can used the Roth for early retirement as long as you won't need income or growth of the investments prior to age 59 and one/half

Answer 4

A Roth IRA is an individual retirement account (IRA) allowed under the tax law of the United States. Named for its chief legislative sponsor, U.S. Senator William V. Roth, Jr. of Delaware, a Roth IRA differs in several significant ways from other IRAs.

A Roth IRA can invest in securities, usually common stocks or mutual funds (although other investments, including derivatives, notes, certificates of deposit, and real estate are possible.) As with all IRAs, there are specific eligibility and filing status requirements mandated by the Internal Revenue Service. A Roth IRA's main advantage is its tax structure. Contributions are made only from earned income that has already been taxed (and is not tax deductible), but withdrawals up to the total of contributions are federal income tax free, and withdrawals of earnings (anything above the total of contributions) are often free of federal income tax.

The total of contributions to all IRAs are limited as seen below (this total may be split up between any number of Traditional and Roth IRAs. If married, both you and your spouse may contribute the amount listed):

Year Age 49 and Below Age 50 and Above
2005 $4,000 $4,500
2006–2007 $4,000 $5,000
2008 $5,000 $6,000


Differences from a traditional IRA
In contrast to a Roth IRA, contributions to a traditional IRA may be tax deductible if certain eligibility requirements are met, but withdrawals are included in the account owner's income (and thus subject to income tax). Another advantage of the Roth IRA over a traditional IRA is that there are fewer restrictions and requirements on withdrawals. With both types of IRA, transactions inside the account (including capital gains, dividends, and interest) incur no tax liability.


Disadvantages
The main disadvantage of a Roth IRA (when compared to a traditional IRA) is that contributions are not tax-deductible. If one contributes $1000 to a traditional IRA while in a high tax bracket, one can often receive a tax deduction, substantially reducing the initial cost of contributing (or, potentially, allowing someone without much disposable income to shelter more income). This is not the case for the Roth IRA. It should be noted that the money in a traditional IRA is taxed once it is withdrawn at retirement. If one is not able to max out one's IRA contributions, and ends up in a lower income tax bracket at retirement, then one will wind up with less usable cash by choosing a Roth IRA over a Traditional IRA.

Also, with a traditional IRA, there are heavy penalties for early withdrawals of earnings (withdrawals up to the total of contributions + conversions are tax-free). An unqualified withdrawal of earnings will result in federal income tax plus a ten-percent penalty on the amount. Fortunately there are many exceptions, such as buying a first home and paying qualified educational expenses.

Finally, there is also the risk that Congress over the next few decades may decide to tax earnings on Roth IRAs.

Advantages
Provided that a taxpayer has earned income (and is within the modified AGI limits), contributions can be made to a Roth IRA at any age.

At any time, the IRA owner may withdraw up to the total of his contributions (in nominal dollars).

If there is money in the IRA due to conversion from a Traditional IRA, the IRA owner may withdraw up to the total of the converted amount, as long as the "seasoning" period has passed on the converted funds (currently, five years).

Withdrawals of more than the total of contributions + seasoned conversions are considered withdrawals of earnings, and are subject to tax and penalty if they are not qualified.

Earnings withdrawals become automatically qualified in the tax year the participant reaches age 59.5 or becomes disabled, so long as the account is "seasoned" (established for five or more years).

Up to $10,000 in earnings withdrawals are considered qualified if the money is used to acquire a principal residence. This house must be acquired by the IRA owner, their spouse, or their lineal ancestors and descendants. The owner or qualified relative who receives the "first time homeowner" distribution must not have owned a home in the previous 24 months.

When a Roth IRA owner dies, and the spouse is the sole beneficiary of that Roth IRA and he or she also owns one, the surviving spouse may combine the two Roth IRAs into a single account without penalty. Additionally, qualified distributions are also available to other beneficiaries of Roth IRA owners. See IRS Pub 590 for complete details.

If the Roth owner expects his/her tax bracket during retirement to be higher than presently, there is a tax advantage to making contributions to a Roth IRA over a Traditional IRA or similar vehicle. There is no current tax deduction, but money going into the IRA is taxed at the lower current rate, and will not be taxed at the higher future rate when it comes out of the IRA. If a taxpayer is currently in the 15% tax bracket, then a $1000 contribution to a traditional IRA would provide a $150 reduction in current-year tax liability. If that taxpayer were in the 30% tax bracket upon retirement, $1000 of traditional IRA distributions would incur $300 in taxes. Therefore, the person would pay twice as much on retirement income as he or she received in tax benefits from the traditional IRA deduction (and since gains are compounded, this comparison is valid). Therefore, the Roth IRA offers a specific advantage where a person will retire in a higher tax bracket than that used during his or her pre-retirement years.

Perhaps the greatest advantage of the Roth IRA is its lack of forced distributions based on age. All other tax-deferred retirement plans, including the Roth IRA's cousin, the Roth 401(k)*, require withdrawals to begin at age 70½ (more precisely, by April 1 of the calendar year after age 70½ is reached), and impose an annual minimum distribution once withdrawals begin at any age beyond 59½. The Roth IRA is completely free of these mandates.

See Final IRS Regulations, passed December 30, 2005 not exempting Roth 401k from mandatory distributions at age 70.5.

[edit] Eligibility: Income limits
Like many tools that offer tax advantages, Congress has limited who can contribute to a Roth IRA, based upon income. A taxpayer can only contribute the maximum amount listed at the top of the page if his or her Modified Adjusted Gross Income (MAGI) is below a certain level (the bottom of the range shown below). Otherwise, a phase-out of allowed contributions runs throughout the MAGI ranges shown below. Once MAGI hits the top of the range, no contribution is allowed at all. The ranges are:

You must be 18 years of age or older earning less than $110,000 (single) or $160,000 (married, filing jointly)
Single filers: Up to $95,000 (to qualify for a full contribution); $95,000-$110,000 (to be eligible for a partial contribution)
Joint Filers: Up to $150,000 (to qualify for a full contribution); $150,000 - $160,000 (to be eligible for a partial contribution)
The lower number represents the point at which the taxpayer is no longer allowed to contribute the maximum yearly contribution. The upper number is the point as of which the taxpayer is no longer allowed to contribute at all. Note that people who are married and living together, but who file separately, are only allowed to contribute a relatively small amount.

However, once a Roth IRA is established, the balance in the account remains tax-sheltered, even if the taxpayer's income rises above the threshold. (The thresholds are just for annual eligibility to contribute, not for eligibility to maintain an account.)