You do not report your Roth individual retirement account's dividend income to the Internal Revenue Service. The purpose of a Roth IRA is to provide tax-sheltered growth and tax-free retirement income. If you observe all the rules, you can withdraw retirement earnings from your Roth IRA any time after you reach age 59½ without taxes or penalties. If you prefer, you can leave some or all of the money in your Roth account for as long as you live.
Dividends in a Roth IRA
Corporations may choose to pay dividends to stockholders. Dividends are cash or stock payments to owners of common and preferred stock. When you own stocks or stock mutual funds in your Roth IRA, the dividends are completely shielded from taxation. It doesn't matter if you automatically reinvest your dividends back into a mutual fund or use them to buy different assets, the effect is the same -- zero taxes while the money remains in the Roth IRA.
IRS Treatment of Roth IRA Earnings
Because you've paid income tax on the money you contribute to a Roth IRA, the IRS is never going to tax or penalize it, no matter when you withdraw it. The IRS does care about earnings, however. Earnings arise from dividends, interest and capital gains. If you obey IRS withdrawal rules, you never pay a red cent in taxes on earnings. If you withdraw earnings prematurely, the IRS will tax them at your marginal interest rate -- the tax on the "last dollar" of annual income. They may also hit you with a 10 percent additional tax, depending on the reason for the premature withdrawal. The IRS won't apply these taxes until you have first withdrawn all of your contributions.
You will always pay taxes and penalties on earnings withdrawn before the Roth's fifth anniversary. After that and until 59 1/2, you have to pay taxes and penalties on withdrawn earnings unless the money was withdrawn because of death, disability or to spend up to $10,000 on your first home. Even if you have to pay taxes for draining earnings too soon, you still may be able to avoid the 10 percent penalty. Publication 590 (page 70) offers a list of ways to avoid the early withdrawal penalty tax, including death, disability, medical costs, education costs, first-time home purchase, payment of taxes on qualified plans and distributions to a qualified reservist.
Substantially Equal Periodic Payments
There is one other way to avoid the 10 percent additional tax when you withdraw earnings before age 59 1/2. You can avoid the penalty by arranging to receive substantially equal periodic payments based on your life expectancy. You will have to pay taxes at your marginal rate on SEPP withdrawals of earnings until you reach 59½. Once you start receiving SEPP, you must continue for five year or age 59½, whichever comes later. After you reach 59 1/2, your SEPP are tax-free.
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