When you purchase a fund for your Roth Individual Retirement Arrangement, you aren't trapped in your investment. You can move your money to another fund anytime you want, just as if you had invested in a regular brokerage account. Since the Roth IRA has special tax rules, there are a few points you need to be aware of before you make a change.
There aren't any tax consequences for changing funds in a Roth IRA. This is because the Roth IRA defers taxes on your investments as long as you keep your money in the account. If you sell your old fund for a gain, you won't need to pay income tax on the gain that year. On the other hand, if you sell your old fund for a loss, you won't get a tax deduction for the loss. There are also no tax consequences for buying a new fund, so your investment change won't have any impact on your tax return for the year.
Mutual Fund Penalties
When you change funds in your Roth IRA, you could run into problems with fund penalties. To reduce excess trading and keep expenses low, some funds charge penalties if you sell off your investment too soon. According to the SEC, funds can charge a flat penalty of up to 2 percent of your investment. Others will block you from reinvesting back in your old fund for a certain amount of time. Before changing funds, you should contact your investment adviser and ask if there will be any mutual fund penalties for your move, or review the fund prospectus if you manage your own investments.
While the Roth IRA avoids taxes on fund changes, it doesn't avoid commissions. When you sell your old fund and buy a new fund, you may incur a commission on each transaction, known as a load. The total amount you need to pay depends on your brokerage and the fee structure of each fund. Some mutual fund companies only offer load funds; if your Roth IRA is held at one of these companies, you won't be able to avoid a load unless the company waives it for trades within retirement accounts.
If you withdraw money out of your Roth IRA as part of your fund change, you could owe taxes. Withdrawals from a Roth IRA are tax-free if they are made after you are 59 1/2 or older. You're also allowed to take out your contributions into the account (but not the earnings) tax- and penalty-free at any time. However, if you are younger than 59 1/2 and take out some of your investment gains, you'll owe income tax plus a 10 percent penalty on the gains, with some situational exceptions. Contact your tax adviser to help you transfer your Roth IRA holdings to an IRA at another institution to avoid adverse tax effects.
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