Reason for Non-taxable Basis

• Roth accounts contain a non-taxable basis because the contributions made to the account did not result in an income tax deduction. This means the money has already been included as taxable income on an income tax return you filed and therefore it will not be taxed a second time later on by the Internal Revenue Service when you take it out. The non-taxable basis of the Roth account only includes your contributoins; it does not grow to include the money earned on those contributions while the money remains in the account.
  
  

Significant for Early Withdrawals

• Early withdrawals from IRAs typically result in early withdrawal penalties. The penalty, however, only applies to the taxable portion of the distribution. According to IRS rules, when you take an early withdrawal from a Roth IRA, you take out your non-taxable Roth basis from your contributions before ever touching the earnings. This allows you to not only avoid the income taxes on an early withdrawal of contributions, but also the 10 percent tax penalty. Any early withdrawals in excess of your non-taxable Roth basis, however, will result in taxes and penalties.
  
  

Complications

• Unlike Roth IRAs, the IRS rules do not permit you to take out all your non-taxable Roth basis first in an early distribution from a Roth 401k or Roth 403 plan. Instead, non-taxable and taxable portions are removed in proportion to the makeup of your account. For example, if your Roth 401k plan is 70 percent non-taxable Roth basis and 30 percent taxable earnings, your early withdrawal would consist of 70 percent non-taxable Roth basis, which is not subject to taxes or early withdrawal penalties, and 30 percent taxable earnings, subject to income taxes and earlt withdrawal penalties. Therefore, you still get some benefit from your non-taxable Roth basis, just not as much as with a Roth IRA.
  
  

Potential for Claiming Losses

• If your Roth IRA or 401k plan has been hard-hit by bad tax returns, you may be able to claim a loss on your income taxes. To do so, you must close all of your Roth IRA accounts and have received less than you contributed for the duration of the account. For example, if your total distributions, including distributions taken before you cashed out the entire account, totaled $15,000 and your total contributions totaled $20,000, you could claim a $10,000 loss because your Roth IRA tax basis exceeds your returns. However, this is still rare and may be unwise because it required liquidating all of your Roth IRAs.