Roth IRAs have significant advantages over traditional IRAs. Since Roth IRAs are funded with after-tax dollars, the withdrawals are tax-free once you have met the criteria – meaning you are age 59-½ or older and have held your Roth IRA for at least five years. These are known as qualified withdrawals.
There are two 60-day windows to consider when withdrawing funds from a Roth IRA: the 60-day rollover window and the window for withdrawing contributions. Let's look at both in detail.
Rollover Window – Roth IRAs are subject to the same 60-day rollover window as traditional IRAs, just with different ramifications for missing the window. You have a 60-day window to roll it over into another Roth IRA account – it cannot be rolled into any other type of retirement account. Once you do this, you cannot rollover any other distributions from either the distributing or receiving IRA for one calendar year from the withdrawal date.
Should you miss this window and you are below age 59-½, the consequences are severe. The attempted rollover will be considered a non-qualified withdrawal, meaning you have lost the tax-free status and you will pay ordinary income tax, plus the early withdrawal penalty of 10%. In essence, your IRA money gets taxed twice.
If you are above age 59-½ and meet the five-year criteria but miss the rollover window, it is considered a qualified withdrawal. You will not have to pay taxes on the principal, but you will have to start over with respect to setting up any new IRA or account.Normally the best way to switch accounts is through direct transfer, with the funds going directly from one financial institution to another without ever passing through your hands. In this case, the 60-day window does not apply. You can also do direct transfers more than once per year, and transfers are not reportable to the IRS.
Withdrawal of Contributions – As noted above, you can make any qualified withdrawal of a Roth IRA after age 59-½. However, you can also make withdrawals of your contributions for any particular year below age 59-½, as long as you pay that amount back to the Roth IRA within 60 days. This applies only to contributions, not earnings.
In essence, your Roth IRA can serve as a short-term, interest-free loan to yourself. This makes for a perfect emergency reserve of cash for any temporary cash-flow problem or large expense.
If you decide not to pay back the contribution to the Roth IRA, the consequence is that you have lost the ability to contribute that amount for the year, up to the $5,000 yearly contribution limit.
For example, let’s say you contributed $2,000 to your Roth IRA in the first four months of the year, and you withdrew $1,500 of that contribution to pay bills. If you don’t pay the money back within the 60-day window, you would only be able to contribute $3,000 more to your Roth IRA for the rest of that year, giving you a limit of $3,500 for that year -- the $500 you did not withdraw plus the $3,000 you added in the last 6 months.
Remember that these 60-day windows are 60 calendar days, not business days. Don't let a simple mistake like that ruin your plans.
Roth IRA's are outstanding retirement investment vehicles, but keep these two important 60-day windows in mind if you want to use your Roth IRA as a rainy day fund – and especially if you are rolling over any Roth IRA into a different one.
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