Tax Liability for Closing a Roth IRA

by Mike Parker

The U.S. Congress first authorized traditional individual retirement accounts (IRA) to provide working taxpayers who were not covered by a qualified retirement plan at work with a means of setting aside some of their earned income in a tax-advantaged account. Subsequent legislation created Roth IRAs, which had some similarities with traditional IRAs but significant differences as well, including the tax consequences for closing the account.

Roth IRA

You can only make contributions to your Roth individual retirement account if you have earned compensation, such as wages, salaries, tips, commissions, bonuses or self-employment income. The amount of your contribution is limited to the the lesser of 100 percent of your earned compensation for the tax year or $5,000 as of the time of publication according to the Internal Revenue Service (IRS). The maximum amount may be extended to $6,000 if you are over 50, and the amount may be reduced or eliminated based on your filing status, the amount of your modified adjusted gross income and certain employment factors. You cannot take an income tax deduction for contributions to your Roth IRA, but qualified withdrawals are free from federal income taxes.

Closing A Roth IRA

The money in your Roth individual retirement account always belongs 100 percent to you. You can withdraw all or any portion of the funds in your Roth IRA at any time for any reason. A Roth IRA is a trustee-based account and the trustee of your Roth account may require you to maintain a minimum amount in the account in order to maintain your Roth IRA as an active account. If you withdraw funds below the minimum, your trustee may close your account. You have no obligation to maintain a Roth IRA account. You may close your Roth IRA anytime you wish.

Tax Consequences for Contributed Amounts

You are not allowed to take a tax deduction for contributions you make to your Roth IRA. All contributions to your Roth IRA are made with after-tax dollars. Since you have already paid income taxes on the funds you used to contribute to your Roth IRA, you may withdraw those funds at any time for any reason without generating a taxable event. If you close your Roth IRA, the IRS will consider all amounts equal to your contributions to be a tax-free return of contribution that does not need to be reported when you file your federal income tax return.

Tax Consequences for Earnings

Earnings that occur within your Roth IRA are allowed to grow without creating a tax obligation as long as they remain in the IRA. The earnings always belong to you and you can withdraw them at any time for any reason. There may be tax consequences regarding the earnings portion of any withdrawals resulting from closing your Roth, depending on your age and how long the earnings have remained in your Roth IRA. Earnings that have remained in your Roth IRA for less than five years will be taxed as ordinary income and will be subject to a 10 percent tax penalty, regardless of your age. Earnings that have remained in your Roth IRA for at least five years are free from federal income taxes if your were at least 59 1/2 years of age when you closed your Roth IRA account. Earnings that have remained in your Roth IRA for at least five years are also free from federal income taxes if you closed your account and used the proceeds to buy or rebuild a first home, or if you became disabled.