By: Patrick Gleeson, Ph. D., | Reviewed by: Ryan co*ckerham, CISI Capital Markets and Corporate Finance | Updated March 06, 2019
In almost all cases, you can change funds (or stocks or any other equity) in a Roth IRA without tax consequences. Only available since 1998, Roth IRAs provide an interesting and popular alternative to traditional IRAs (Individual Retirement Arrangements). By 2014 they'd accumulated over $500 billion in assets, providing investors a unique opportunity not only to defer taxes on retirement accounts, but after an initial taxable event, to avoid them altogether. Here's how this works.
Tip
Generally speaking, you can change the specific funds in your Roth IRA account without incurring tax penalties.
Roth IRAs and Taxes
When you invest in a traditional IRA, (or a 401(k) or any retirement investment other than a Roth IRA), you invest the money before you've paid taxes on it. The money can grow for decades without being taxed. In retirement, however, as you draw money from the IRA for retirement expenses, you have to pay income tax on the amount withdrawn.
With a Roth IRA, you pay taxes on the money at the time you invest it. But, here's the unique advantage: the money can grow in the account for decades and when you withdraw it in retirement, withdrawals are tax-free. When you think about this, you'll see that Roth IRAs provide investors an incredible advantage, and particularly for the newer and younger investors who typically open these accounts.
Example of the Benefits of a Roth IRA
For instance, if you begin investing in your Roth IRA at age 30, and make the maximum allowable investment for investors 50 and under of $5,500 each year, then step up your annual contributions to the annual maximum of $6,500 until your retirement at age 70, you'll have contributed a total of $240,000.
If you've invested the money in a Standard & Poor's 500 index fund with an average long-term gain of 10 percent, when you've reached 50 you'll have accumulated more than $360,000. By the time you retire at 70, with your stepped-up contribution of $6,500 that's allowed at age 50, you'll have over $2.8 million in your Roth! (Please note that these returns are an approximation that do not account for daily compounding. While an approximation, the differences are not considerable).
But here's the best part: you've contributed a total of $240,000, less than 10 percent of what you've got in the account. You've paid income taxes on the contributed amount each year. But the entire amount of more than $2.8 million is yours to withdraw in retirement entirely free of taxes.
Switching Investments in a Roth IRA
In an individual investment account – one that's not entitled to the advantages of a retirement account – whenever you sell an equity at a profit, even if you immediately buy another equity to replace it, you've still created a taxable event. Depending upon how long you've held the equity, you'll either pay taxes on the gain at the so-called "short-term capital gains rate," which is really just the ordinary income tax rate, or at best, you'll pay at the long-term capital gains rate, which for a majority of investors will be 15 percent.
In a Roth IRA, however, you're free to switch equities – selling current equities at a profit and then reinvesting in a different equity – as often as you like, tax-free. Period. There are no other qualifications. You can reinvest or not. Not that it's a great idea, but there are no tax consequences even if you keep the money in cash, so long as you leave it in the Roth IRA.
A Potential Warning
The above information is based on the assumption that you're buying and selling either mutual funds, ETFs or individual stocks of public corporations called C corporations, which is what almost all investors normally do. Few investors, however, also invest in S corporations, LLCs (limited liability companies) or Master Limited Partnerships.
For complicated tax reasons that go beyond the limits of this article, holding such investments in a Roth IRA doesn't provide the same tax advantages and tax advisers generally advise against holding them in a retirement account. Since the issue can be complicated, it's a good idea to get advice from a tax specialist about what's best for you.
FAQs
You can change your individual retirement account (IRA) holdings from stocks and bonds to cash, and vice versa, without being taxed or penalized. The act of switching assets is called portfolio rebalancing.
Can I change my Roth IRA contribution amount? ›
No. Beginning January 1, 2018, the IRS no longer allows recharacterizations of Roth conversions.
Can you change your Roth IRA contributions without penalty? ›
You can withdraw contributions you made to your Roth IRA anytime, tax- and penalty-free. However, you may have to pay taxes and penalties on earnings in your Roth IRA.
Can you move money between Roth IRA accounts? ›
Roth IRAs can be transferred to a new custodian tax- and penalty-free if you follow IRS rules. A direct transfer between two custodians—or financial institutions—is the safest way to move Roth IRA funds from one Roth IRA retirement account to another. A transfer must be deposited in the new account within 60 days.
Can you change asset allocation in Roth IRA? ›
Adjusting the allocation of your assets within a Roth IRA allows you to diversify your investments across different asset classes, industries, and regions. This reduces the risk of having all your eggs in one basket and can protect your portfolio from market volatility while potentially increasing long-term growth.
At what age does a Roth IRA not make sense? ›
Even when you're close to retirement or already in retirement, opening this special retirement savings vehicle can still make sense under some circ*mstances. There is no age limit to open a Roth IRA, but there are income and contribution limits that investors should be aware of before funding one.
How do I correct a Roth IRA contribution? ›
Key Takeaways
You can withdraw the money, recharacterize the excess contribution into a traditional IRA, or apply your excess contribution to next year's Roth. You'll face a 6% tax penalty every year until you remedy the situation.
Can you replace Roth IRA contributions? ›
You can put funds back into a Roth IRA after you have withdrawn them, but only if you follow very specific rules. These rules include returning the funds within 60 days, which would be considered a rollover. Rollovers are only permitted once per year.
What happens if I put more money in my Roth IRA? ›
The IRS puts annual income limits on a Roth IRA. When you exceed that limit, the IRS generally charges a 6% tax penalty for each year the excess contributions remain in your account. This is triggered at the time you file each year's taxes, giving you until that deadline to remove or recharacterize the misplaced funds.
Can I rebalance my Roth IRA without penalty? ›
For example, rebalancing your assets in tax-advantaged accounts like a 401(k), IRA, or Roth IRA, will not incur any short- or long-term capital gains taxes. Alternatively, capital gains generated in standard investment accounts are taxable by the US government.
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.
What are the disadvantages of converting to a Roth IRA? ›
Since a Roth conversion increases taxable income in the conversion year, drawbacks can include a higher tax bracket, more taxes on Social Security benefits, higher Medicare premiums, and lower college financial aid.
Can you have two Roth IRAs? ›
Can You Have More than One Roth IRA? You can have more than one Roth IRA, and you can open more than one Roth IRA at any time. There is no limit to the number of Roth IRA accounts you can have. However, no matter how many Roth IRAs you have, your total contributions cannot exceed the limits set by the government.
Can I change my Roth IRA investment? ›
You can trade actively in a Roth IRA
Some investors may be concerned that they can't actively trade in a Roth IRA. But there's no rule from the IRS that says you can't do so. So you won't get in legal trouble if you do. But there may be some extra fees if you trade certain kinds of investments.
How many times can you move a Roth IRA? ›
IRA Transfer Rules
Only one transfer may be made per 12-month period. This applies to all IRA accounts you may own except trustee-to-trustee transfers or those to another IRA. Money can be transferred to most types of IRA and retirement accounts.
Can I switch mutual funds in my IRA? ›
If your IRA is maintained by a brokerage, you should be able to shift around your investments from one mutual fund to another, or to and from individual stocks such as Home Depot (NYSE:HD) , Coca-Cola (NYSE:KO) , or Intel (NASDAQ:INTC) .
Can you take money out of a Roth IRA and put it back in? ›
You can put funds back into a Roth IRA after you have withdrawn them, but only if you follow very specific rules. These rules include returning the funds within 60 days, which would be considered a rollover. Rollovers are only permitted once per year.
What is the 5 year rule for Roth IRAs? ›
The Roth IRA five-year rule says you can withdraw your investment earnings tax-free and penalty-free as long as you've held the account for at least five years. It's important to note this rule applies specifically to investment earnings.
What is the backdoor Roth 5 year rule? ›
Accessed Apr 8, 2022. You'll need the money in five years or less. Money converted from an IRA to a Roth IRA falls under a Roth five-year rule: If you don't wait five years to withdraw it, you could owe taxes and a 10% penalty. The withdrawal from your IRA will push you into a higher income tax bracket.
