taxes

Tax Rules for Roth Withdrawals

There is a waiting period before you can take out earnings tax-free.

I am 66 and considering a 401(k) conversion to a traditional IRA and then into laddered Roth IRA CDs. I plan to live on the interest earned by the CDs, but I have been told that if I withdraw the interest within five years of the conversion, it will be taxed. Is that true?

No. The interest you withdraw won’t be taxed, but it’s easy to understand the confusion.

The law does set a five-year waiting period before earnings may be withdrawn from a Roth tax-free, regardless of the age of the IRA owner. You don’t have to worry about that, though, thanks to the so-called ordering rule. It holds that the first money withdrawn from a Roth IRA is considered to be money you put in by annual contributions -- and it comes out tax- and penalty-free at any age. Once you’ve withdrawn all your contributions, you begin to dip into converted amounts (tax-free at any age and penalty-free for those age 59½ and older). Only after you have withdrawn all the contributions and converted amounts do you tap into earnings, which will be taxed if you withdraw them within five years of the conversion.

So you needn’t fret that the money you’ll be withdrawing is really interest earned on the CDs. That’s not the way the law sees it. Only after you have depleted all contribution and converted amounts does the IRS think you’re dipping into earnings. And, if five years have passed since the conversion, that money will be tax-free, too.For more information, see FAQs on the Roth Conversion Rules.

Most Popular

When Could We Get a Third Stimulus Check?
Coronavirus and Your Money

When Could We Get a Third Stimulus Check?

President Biden and others in Congress are pushing for a third-round of stimulus checks, but it might be a while before we get them.
January 20, 2021
Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer
Coronavirus and Your Money

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer

The IRS has an online tool that lets you track the status of your second stimulus check.
January 18, 2021
20 Best Stocks to Buy for the Joe Biden Presidency
stocks to buy

20 Best Stocks to Buy for the Joe Biden Presidency

Joe Biden has been sworn in as America's 46th president. These are 20 of the best stocks to own under the new administration.
January 20, 2021

Recommended

What Could 2021 Hold for Your Finances?
retirement planning

What Could 2021 Hold for Your Finances?

After a wild 2020, many of us are ready for a fresh start in the new year.
January 22, 2021
Don’t Have a Pension? The SECURE Act Could Help
retirement planning

Don’t Have a Pension? The SECURE Act Could Help

If you’re worried about retirement, the SECURE Act has a lot to offer. It has several provisions to allow people to save more, for more years — and it…
January 22, 2021
President Biden's Tax Plans for the Next Few Years
Politics

President Biden's Tax Plans for the Next Few Years

With control of both the House and Senate in Democratic hands, President Biden will be able to get more of his tax agenda through Congress. Here's wha…
January 20, 2021
Unhappy with Low CD Rates? A Structured Note May Be the Answer
retirement planning

Unhappy with Low CD Rates? A Structured Note May Be the Answer

What are structured notes? How do they limit risk while allowing for gains? Considering their pros and cons, could a structured note be right for you?…
January 20, 2021