Roth IRA's

[laurinsane]

I have a question about Roth IRA's. I would like to retire in my 40s, I'm going to be 25 next month. I have been savind 11% in my 401k and hope to increase that to 15% by the end of the year (when I get a permanent full time position at work). I would like to also start a Roth IRA.

I know Roth IRA's are after tax contributions so no taxes will be taken out when I start withdrawing. My question is if I plan on retiring before the elligable age for withdrawing money how will this work penalty wise?

Would just like to know my options. Thanks.

 

[kombat]

I'm in Canada, so take this with a grain of salt, but from what I understand, withdrawals from Roth IRA's prior to age 59 and a half are subject to a 10% penalty.

However, I wanted to ask you about your general plan. You say you're 25 now and plan to retire at 40. That's only 15 years. That's possible, with aggressive saving and robust market performance. On the other hand, you said you're only contributing 11% (soon 15%) of your income to retirement. That makes me question whether or not you have a realistic expectation of how much money you'll need in order to retire so early.

Could you please tell us what your target amount is? How much do you expect you need to save up in order to retire at age 40?

 

[laurinsane]

I didn't mark off 40 as the cut off but my 40s in general.

Currently I contribute 11% (with a 4% match) to my 401k (~$8000 to date) to be increased to 15, 20% depending on whether whether the internal job I applied for falls into place. I'll have more security and won't be paying $600/mo for health insurance (hence extra money for Roth IRA).

I also have an annuity fund with ~ $6000, a vanguard index fund I opened recently with $3000 contributing $200/mo. I also have a 2-family rental property I am in the process of paying off. I am breaking even on that at the moment. Just refinanced so waiting to see how that pans out financially.

So in total I'm planning on saving $17k-$20k a year, as I keep my expenses low. I spend about half of what I make.

So I just wanted to know how the whole Roth IRA thing pans out.

 

[kombat]

Sounds like you're definitely on the right track, congratulations. You're doing all the right things.

That said, I still think aiming for mid-40's might be a little ambitious. Assuming you have $17,000 invested now and will add another $20,000 each year, and the market returns 8%, you'd only have around $1,000,000 at age 45.

That's why I asked you about your expectations, I wasn't sure if you had a realistic picture of how much money it takes to retire. $1,000,000 might be barely enough to retire at 65 (with Social Security and maybe a company pension picking up the slack), but it's nowhere near enough to retire at age 45, especially considering you're still looking at 20 years of inflation between now and then.

 

[laurinsane]

Well I'm not a big spender. I don't keep up with the trends now and buy flashy gadgets and accessories. I don't even have cable. Oh the horror!!!!! I can't see wasting $100 a month on it. My car was bought used and paid in full a few year ago. Just reached the 100k mark and I plan to keep it for another 100k before I look for another used car.

I plan on my living expenses in retirement to be much less than average person who needs a 4 BR house with a TV in every room and a 2 car garage filled with to new shiny Cadillacs and expensive clothes.

I was diagnosed with Hodgekin's Lymphoma when I was 16 so I know the value of what really counts in your life. Fortunately for me, cable and new cars don't happen to be one of those.

 

[sarahsays]

From what I understand about Roths, once you've had the account for 5 years, you can take out the money you've contributed (not earnings, just actually contributions) without paying penalties or taxes.
That said, after maxing out your Roth, you should still try to save some in taxable accounts, which will be easier to tap during your earlier retirement years.

 

[kombat]

Again, I'm really glad to read that you've put a lot of thought into this. It shows you're committed to being prepared, and puts you ahead of about 90% of your peers.

I don't mean to be condescending, but are you familiar with the concept of the "Safe Withdrawal Rate", often abbreviated SWR? It represents a commonly-agreed-upon percentage that is safe to take from your portfolio during retirement, without eroding the principle too quickly. The usual amount is 4%. That means that you should have retirement assets valued at 25 times your current living expenses. A nest egg of $1 million will only provide $40,000/year at the standard SWR, and that's before taxes. And keep in mind, we're talking about 20 years from now, so realistically, that'd be like trying to live off roughly $20,000/year today, thanks to the effects of inflation.

A million dollars doesn't go as far as people think, and it'll go even less far 20 years hence.

You've got a great attitude, and it sounds like you're able to live quite cheaply. Just remember that life can throw unexpected expenses at you. It's noble to plan to make your car last another 10 years, but if someone rear-ends you and totals it (it happened to us), you need to have a backup plan in place to replace it.

You've certainly come to the right place. Feel free to ask for specific advice or evaluations of your plan, I'm sure the other members here would be glad to share their insight and experience.

 

[kaneohe]

From what I understand about Roths, once you've had the account for 5 years, you can take out the money you've contributed (not earnings, just actually contributions) without paying penalties or taxes.

Distributions (quote below from fairmark.com)
Distributions from Roth IRAs are tax-free until you've withdrawn all your regular contributions. After that you'll withdraw your conversion contributions, if any. When you've withdrawn all your contributions (regular and conversion), any subsequent withdrawals come from earnings. Withdrawals of earnings are tax-free if you're over age 59½ and at least five years have expired since you established your Roth IRA. Otherwise (with limited exceptions) they're taxable and potentially subject to the early withdrawal penalty

 

[crazy connie]

I have a question about Roth IRA's. I would like to retire in my 40s, I'm going to be 25 next month. I have been savind 11% in my 401k and hope to increase that to 15% by the end of the year (when I get a permanent full time position at work). I would like to also start a Roth IRA.

I know Roth IRA's are after tax contributions so no taxes will be taken out when I start withdrawing. My question is if I plan on retiring before the elligable age for withdrawing money how will this work penalty wise?

Would just like to know my options. Thanks.

The option for early retirees is 72T. Might I suggest reading at: 72(t) on the Net Discussion Forum

These folks help you to understand the options for getting at your retirement savings early. Also, you can be sure of a lot of IRS changes before you get there! Read and learn continually as you save and you will have fun meeting your goals.

 

[laurinsane]

Hey thanks for the links and information I will definitely check them out.

 

[LOL!]

I think it is a moot point. I think if you wish to retire in your 40's that you are gonna have to have some investments outside of your 401(k) and Roth IRA. You are gonna have to max out these accounts with their piddly little limits and then put even more in a taxable account. With even more in a taxable account, you are not gonna need to know what to do with a Roth. Just let it sit there when you are retired early.

 

[laurinsane]

Thanks again. Yes I have a Vanguard accoun that I also contribute to regularly.

 

[jIMOh]

I have a question about Roth IRA's. I would like to retire in my 40s, I'm going to be 25 next month. I have been savind 11% in my 401k and hope to increase that to 15% by the end of the year (when I get a permanent full time position at work). I would like to also start a Roth IRA.

I know Roth IRA's are after tax contributions so no taxes will be taken out when I start withdrawing. My question is if I plan on retiring before the elligable age for withdrawing money how will this work penalty wise?

Would just like to know my options. Thanks.

You could take out deposits without penalty (from a Roth) prior to age 59.5.

My advice would be to increase savings in taxable accounts too (so 15% to 401k, 5k to Roth and another 2-5k to a taxable account) so you can tap into investments in a way which makes sense for you, without incurring any penalties.

 

[travelover]

Thanks again. Yes I have a Vanguard account that I also contribute to regularly.

Since you are starting, it is important to invest in tax efficient funds in your taxable account. A great start is the Vanguard Total Market fund. This will keep your taxable capital gains and dividends low so you'll save on taxes every year and build up your nest egg faster.

 

[laurinsane]

Great!!! I will look into that. Is that an index fund?

 

[Art G]

Type of Distribution

Even after you meet the five-year test, only certain types of distributions are treated as qualified distributions. There are four types of qualified distributions:

• Distributions made on or after the date you reach age 59½.
• Distributions made to your beneficiary after your death.
• If you become disabled, distributions attributable to your disability.
• "Qualified first-time homebuyer distributions."

A distribution of earnings that fails to meet these tests will be taxable, and may be subject to a penalty as well.

I'm kind of curious though, if you plan to retire in your 40's and live frugally going forward, what do you plan to do in your retiremtnt? I can't imagine retiring and knowing you can't afford to enjoy it.

 

[teejayevans]

Type of Distribution

Even after you meet the five-year test, only certain types of distributions are treated as qualified distributions. There are four types of qualified distributions:

• Distributions made on or after the date you reach age 59½.
• Distributions made to your beneficiary after your death.
• If you become disabled, distributions attributable to your disability.
• "Qualified first-time homebuyer distributions."

A distribution of earnings that fails to meet these tests will be taxable, and may be subject to a penalty as well.

I'm kind of curious though, if you plan to retire in your 40's and live frugally going forward, what do you plan to do in your retiremtnt? I can't imagine retiring and knowing you can't afford to enjoy it.

For Roths, the above only applies to earnings.
Assuming you pass the 5 year test:
Contributions are taken out first in first out
then conversions (again FIFO)
then earnings

note that means if you do the following:
year 1 5K contribution to Roth IRA
year 2 5K " "
year 3 10K conversion from regular IRA
year 4 5K contribution
year 5 5k contribution
...
year 8 pull out 20K
the 20K consists of year 1+2+4+5
and you'll pay penalties for pull out pulling out contributions
before the 5 waiting period.
TJ

 

[kaneohe]

For Roths, the above only applies to earnings.
Assuming you pass the 5 year test:
Contributions are taken out first in first out
then conversions (again FIFO)
then earnings

note that means if you do the following:
year 1 5K contribution to Roth IRA
year 2 5K " "
year 3 10K conversion from regular IRA
year 4 5K contribution
year 5 5k contribution
...
year 8 pull out 20K
the 20K consists of year 1+2+4+5
and you'll pay penalties for pull out pulling out contributions
before the 5 waiting period.
TJ

That is not my impression. I reposted the Fairmark quote below.
There appear to be no time restrictions on tax-free withdrawals of
contributions ---only earnings and possibly conversions.
***************************************************************
Distributions (quote below from fairmark.com)
Distributions from Roth IRAs are tax-free until you've withdrawn all your regular contributions. After that you'll withdraw your conversion contributions, if any. When you've withdrawn all your contributions (regular and conversion), any subsequent withdrawals come from earnings. Withdrawals of earnings are tax-free if you're over age 59½ and at least five years have expired since you established your Roth IRA. Otherwise (with limited exceptions) they're taxable and potentially subject to the early withdrawal penalty
****************************************************************
Here's a quote from p 126 of Pub 17:

Are Distributions Taxable?
You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your
Roth IRA(s). (edited to mention: again no reference to any time limits)

 

[travelover]

Great!!! I will look into that. Is that an index fund?

Yes.

 

[teejayevans]

That is not my impression. I reposted the Fairmark quote below.
There appear to be no time restrictions on tax-free withdrawals of
contributions ---only earnings and possibly conversions.
***************************************************************
Distributions (quote below from fairmark.com)
Distributions from Roth IRAs are tax-free until you've withdrawn all your regular contributions. After that you'll withdraw your conversion contributions, if any. When you've withdrawn all your contributions (regular and conversion), any subsequent withdrawals come from earnings. Withdrawals of earnings are tax-free if you're over age 59½ and at least five years have expired since you established your Roth IRA. Otherwise (with limited exceptions) they're taxable and potentially subject to the early withdrawal penalty
****************************************************************
Here's a quote from p 126 of Pub 17:

Are Distributions Taxable?
You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your
Roth IRA(s). (edited to mention: again no reference to any time limits)

I reread pub 590 again, yea they don't say one or another, I wouldn't
assume one way or another and would like to see it explicitly stated.
Also I like to know if the that applies to conversions as well as
contributions.
TJ

 

[kaneohe]

I reread pub 590 again, yea they don't say one or another, I wouldn't
assume one way or another and would like to see it explicitly stated.
Also I like to know if the that applies to conversions as well as
contributions.
TJ

TJ, I agree w/ you that it isn't explicitly stated in Pub 590 or Pub 17.
Perhaps this might make you feel more comfortable.
Fairmark Forum :: Retirement Savings and Benefits :: Withdrawal of contributions from Roth IRA

My interpretation is that "original" contributions are not subject to the 5 yr rule and can be withdrawn anytime w/o penalty but conversion contributions are subject to the 5 yr rule and penalties. What do you think?

 

[teejayevans]

TJ, I agree w/ you that it isn't explicitly stated in Pub 590 or Pub 17.
Perhaps this might make you feel more comfortable.
Fairmark Forum :: Retirement Savings and Benefits :: Withdrawal of contributions from Roth IRA

My interpretation is that "original" contributions are not subject to the 5 yr rule and can be withdrawn anytime w/o penalty but conversion contributions are subject to the 5 yr rule and penalties. What do you think?

I think this would be a great question to feed to one the popular
financial planner radio shows (Ray Lucia, Ric Edelman). Since I don't
plan on doing before 5 years anyway, it's a mute point for me, but if
I did I would want to get an answer from a better source.
TJ

 

[AnyBody]

I reread pub 590 again, yea they don't say one or another, I wouldn't
assume one way or another and would like to see it explicitly stated.
Also I like to know if the that applies to conversions as well as
contributions.
TJ

Publication 590 is explicit:

"You do not include in your gross income ...distributions that are a return of your regular contributions from (sic) your Roth IRA(s)."

and

"Unless one of the exceptions listed below applies, you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions." (emphasis added)

This makes sense, since regular contributions are per se with after-tax money and there is no "taxable part" to apply the 10% penalty to.

Conversion contributions are different--each conversion contribution must meet its own five-year test or the "taxable part" is subject to the 10% penalty, unless it meets one of the 10 exceptions that apply to both Roth and traditional IRAs ("1st time home buyer" etc).

Again, this makes sense. The Roth conversion is itself one of the exceptions to the 10% penalty for the early distribution of a traditional IRAs (i.e. the conversion is treated as a rollover--code G in box 7 of Form 1099R). However, if you do not meet the safe harbor of the five-year test for that specific conversion contribution, then the 10% penalty applies to the "taxable part." Once again, this make sense. When you convert a traditional IRA to a Roth, there could be both a non-taxable part and a taxable part (you pay the taxes but not the penalty on this part when you make the conversion.) The non-taxable part would be the after-tax contributions to the traditional IRA as reported on Form 8606 and the taxable part would be any pre-tax contributions and all earnings. You can't avoid the 10% penalty on pre-59 1/2 distributions on the taxable part simply by "washing" it through a Roth (unless you meet the Roth's 5-year test.) The non-taxable part is the same as a regular Roth contribution,i.e. both are made with after-tax funds and neither are ever subject to tax or penalty.

Hope this helps. (Huckabee was right--we have to simplify this quagmire.)

 

[AnyBody]

1

 

[kaneohe]

Anybody-----good explanation w/ emphasis on bolding the key word.

Another independent answer citing same references as you. Thanks.
Ed Slott's IRA Forum :: View topic - Withdrawal of Contributions from Roth IRA