You may exchange mutual funds or other securities inside your Roth IRA account without incurring any tax penalties. This also applies to regular IRAs. However, the two kinds of IRAs vary in what occurs when you sell a mutual fund and take the proceeds.
In contrast, if you own mutual funds or other assets outside of IRAs or other tax-advantaged accounts, you must pay taxes on your earnings every time you sell a fund—even if you’re just shifting money from one fund to another within the same mutual fund firm.
- You may exchange mutual funds inside your Roth IRA (or regular IRA) without incurring any tax penalties.
- If you intend to sell a mutual fund in a Roth IRA and take the proceeds, you will not be taxed as long as you fulfill the qualified distribution rules.
- When you take assets from a typical IRA in retirement, you will be taxed.
Tax Differences Between Roth and Traditional IRAs
Both forms of IRAs enable you to avoid paying taxes on capital gains or other income generated by your account each year, but they work differently in terms of the tax advantages they provide.
The money you put into a Roth IRA is taxed as part of your income in the year you make the contribution, at your current marginal tax rate. There are no taxes on qualifying distributions when you take the money in retirement.
Traditional IRA contributions, on the other hand, are made using pretax income, which means the money is not taxed at the time of contribution but will be taxed when you draw distributions from the account. This covers both your initial investment as well as their profits. Traditional IRAs provide a tax advantage right away—you deduct contributions in the year they are made and pay taxes on withdrawals later.
You may withdraw your Roth IRA contributions (but not profits) at any time, tax-free and penalty-free.
Qualified Distribution Requirements
The treatment of profits when withdrawn from a Roth IRA differs dramatically from that of a standard IRA. The tax is just delayed with a regular IRA, and you must pay taxes on your contributions and any profits at your standard income tax rates. That money is tax-free if you have a Roth IRA and fulfill the conditions for a qualified distribution. Typically, this implies you must be at least 5912 years old and have had the account for at least five years, however there are a few exceptions.
For example, assume you have a mutual fund in a Roth IRA that has grown to $15,000 from your original $5,000 commitment and you wish to sell it and extract the money. Assuming it’s a qualified distribution, neither your $5,000 original investment nor your $10,000 profit is taxed, and you may spend the whole $15,000 as you see appropriate.
However, with a conventional IRA, your whole distribution for the year in which you take it will be taxed at your marginal tax rate for ordinary income (unless you are 5912 or older, in which case you will additionally suffer a 10% penalty on the withdrawal). So, if your marginal tax rate is 22%, your $15,000 withdrawal would cost you $3,300 in taxes and earn you just $11,700. Your state may want a piece of it as well.
Meanwhile, if you kept the money in a non-tax-advantaged account, such as a conventional brokerage account, your profit ($10,000) would be taxed at your long-term capital gains tax rate rather than your income tax rate. If it’s 15%, you’d owe $1,500 in taxes.
Do You Pay Capital Gains in a Roth IRA?
Earnings from a Roth IRA are not taxed as long as you follow the qualified distribution conditions. To qualify for a distribution, you must have owned the Roth IRA for at least five years and be at least 5912 years old.
What Investments Do Roth IRAs Allow?
A Roth IRA may hold almost any financial asset (and traditional IRAs too).Among the exclusions are life insurance and antiques.
How Much Is the Early Withdrawal Penalty?
For a Roth or regular IRA, the early withdrawal penalty is 10% of the amount withdrawn before the age of 5912. In addition to the penalty, you may owe income tax. You may withdraw contributions (but not profits) from a Roth IRA at any time without incurring tax or penalty.
The Bottom Line
Don’t allow worries about tax repercussions prevent you from selling mutual fund shares (or other assets) to lock in profits inside your Roth IRA. Qualified Roth IRA distributions are tax-free. However, if you sell a mutual fund in a conventional IRA and intend to take the funds, you will almost certainly owe some tax.
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