Earnings on investments within your Roth IRA that
are reinvested within your Roth IRA do
not increase your basis in your Roth IRA.
Your basis in your Roth IRA is the total amount of post-tax money that
you have contributed to your Roth IRA. There are three categories
- The amount that you have contributed directly to your Roth IRA
over the years. Remember that you did not get to deduct these
contributions on your tax returns and so this is post-tax money.
- Any basis that you had in your Traditional IRA account that you
converted and transferred into your Roth IRA. This basis is the
sum of all the nondeductible contributions you made to your
Traditional IRA (and reported on Form 8606, I hope). This is
post-tax money since you didn't get to deduct these
contributions on your tax returns.
- Any other amounts that you converted from your
Traditional IRA and transferred to your Roth IRA.
These are typically the tax-deductible contributions
that you made to your Traditional IRA plus the
tax-deferred earnings (or losses) within the Traditional
declared these amounts as taxable income and paid income taxes on
them as part of the conversion and transfer process
and so this is also post-tax money.
Your basis is post-tax money, and you are entitled to
withdraw all or any part of it from your Roth IRA without
having to pay income tax all over again on the amounts.
The first two categories have the advantage that they
can be withdrawn at any time without incurring the 10%
tax penalty for early withdrawal, but the third category
will incur the 10% penalty for early withdrawal if it
is withdrawn too soon. Can you play games with the
amounts and say that you are withdrawing one kind of
money and not the other? No, you cannot. The IRS rules
say that the amount withdrawn is counted against the
first category (direct contributions), and when all that
money has been withdrawn, the rest is counted
against the second and third
categories in order of seniority: the oldest amounts
come out first. Any earnings within your Roth IRA
are deemed to have been withdrawn only after your
entire basis (remember: basis means post-income tax money that you
contributed to your Roth IRA) has been withdrawn
completely. These earnings are tax-free and penalty-free
as long as they are a Qualified Distribution (meaning
after the later of 5 years after account was opened
and age 59.5 or meeting one of the exceptions) but
are subject to both income tax and 10% penalty
if they are not Qualified Distributions
To forestall your next questions, I remind you that
In the eyes of the law, you have only one Roth IRA, and so taking
earnings from your Roth IRA investment account in Brokerage A and investing those in your Roth IRA investment account in Brokerage B does not
count as a contribution and does not increase your basis. This
case is covered by the block-quoted sentence in bold face above
because you have only one Roth IRA in the eyes of the law, and
the money transferred over from Brokerage A to Brokerage B is
entirely within your Roth IRA.
You can update "your basis" as per your understanding using
your monthly IRA statements in your personal money management
software program so that you feel good (or bad) about your
Roth IRA investments, but doing so does not change what the
law regards as your basis in your Roth IRA.
There is no constitutional requirement that tax laws have to
have a rationale, or be reasonable according to what you or
anyone else thinks is reasonable, or agree with what you
have recorded in your personal money management program as
"your basis" in your Roth IRA.
If you don't like the law, don't ask in this forum why the
law is the way it is; we have no answer that will satisfy
you. Instead, write to your Congress-critter
demanding that the law be revised to read the way you want it
to read. If your Congress-critter does not agree to do what you
want, an election is coming up in a few months' time.