Are Reinvested Dividends & Capital Gains Taxable in a Roth IRA?

by Herb Kirchhoff

    A Roth individual retirement arrangement allows you to build up a retirement account that will produce tax-free income in your retirement years. With a Roth account, you contribute after-tax income, and your earnings on that money grow tax-free. Many Roth IRA owners invest in the stock market but are uncertain about the tax status of dividends and capital gains on their Roth stock portfolio.

    Earnings in a Roth IRA, including capital gains and dividends on Roth stock investments, are not subject to federal or state income taxes during your working years, so long as you keep the funds in the Roth account until retirement. Once you reach the IRA retirement age of 59.5 years, you can withdraw your stock gains and dividends from your Roth account tax-free and penalty-free, so long as your Roth account has been open more than five years.
    Roth stock gains and dividends will be taxable if they are withdrawn from a Roth account that is less than five years old, even if you are older than 59.5.

    Your stock dividends and capital gains could become taxable if you withdrew them from your Roth IRA before you turned 59.5.
    The Internal Revenue Service charges Roth IRA withdrawals first against your contributions. Because your contributions were after-tax funds, you owe no tax or penalty on them. But any withdrawal that exceeds your contributions is charged to earnings. Earnings withdrawn early from a Roth are taxed as ordinary income even if they came into the Roth from capital gains, which normally would be taxed at a lower rate.

    Your reinvested stock dividends and capital gains will remain untaxed if you roll over the funds from one Roth to another Roth. The IRS views Roth-to-Roth rollovers as non-taxable transactions because the funds stay within a Roth account for retirement purposes.
    The rollover must be completed within 60 days, or the earnings become subject to tax. If you funded your Roth IRA with rollovers from another retirement account, the five-year mandatory interval between deposit and withdrawal runs separately for each rollover, starting on the date each rollover was completed.

    You will also have to pay a 10 percent early-withdrawal penalty tax on your Roth stock earnings, unless they were withdrawn early to buy your first home, pay extraordinary medical expenses, pay health insurance premiums after a loss of job, pay college tuition, or were part of an annuity providing equal periodic payments over your life expectancy.

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    About the Author

    Herbert Kirchhoff has over 35 years experience as a newspaper and newsletter reporter, writer and editor, with 27 of those years spent on telecommunications industry policy issues. Kirchhoff has a B.A. in journalism from Rider University in New Jersey and has been published in the "Trenton (N.J.) Times" and in "Communications Daily" and State Telephone Regulation Report, Washington, D.C.

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