Understanding Roth IRA Withdrawal Rules
Key facts
- Roth IRA contributions are taxed but withdrawals are not.
- There is no current mandatory distribution age, nor are there restrictions on withdrawing your contributions.
- If your account is more than five years old, you can take unlimited distributions of earnings income after the age of 59 ½.
- Non-qualified distributions of earnings before retirement age may result in a 10% tax penalty.
Many investors saving for retirement find that the Roth IRA is ideally suited for their financial goals because it offers an opportunity to set money aside to grow tax-free, and there is no minimum withdrawal age on contributions. These features make the Roth IRA a unique solution to wealth management needs. However, in order to fully avoid taxes and penalties, there are some rules to keep in mind with respects to Roth IRA distributions.
Roth IRA Withdrawal Rules
The primary difference between Roth IRA and other retirement products is that contributions are taxed in the year they are earned. Therefore, contributions can be withdrawn at any time without taxes or penalties. For example, if you have contributed $20,000 to your Roth IRA over the years and it is now worth $25,000, your account has $20,000 of contributions and $5,000 of earnings. You can withdraw up to $20,000 at any time because you have already paid taxes on it. However, if your withdrawal exceeds that amount and dips into the $5,000 of earnings, you may be subject to taxes and penalties if you do not meet the requirements for a qualified distribution.
There is an important caveat to this rule: you must be able to show how much of your Roth account is made up of your contributions and how much is earnings if you want to make a contribution-only withdrawal that is tax and penalty-free. Even if you don’t expect to use your Roth IRA funds before retirement, be sure to keep documentation of your contributions. After all, you never know when an emergency expense will come up.
Qualified Distributions vs. Non-Qualified Distributions
When taking a distribution that includes earnings, Roth IRA withdrawal rules state that if certain eligibility requirements are met, the funds are distributed tax and penalty-free. Distributions eligible under IRS regulations are referred to as qualified distributions, while withdrawals that do not meet requirements are referred to as non-qualified distributions. Understanding the difference is critical to avoiding significant tax liability.
There are two factors in determining whether a withdrawal meets Roth IRA qualified distribution rules. First, you must be aged 59 ½ or older. Second, your first contribution must have been made at least five years ago. If these two criteria are met, there are no taxes or penalties assessed on your withdrawal of both contributions and earnings. However, in certain situations, you might be eligible for a qualified distribution, even if you are not 59 ½ years old. However, that the five-year rule always applies.
These additional situations include the following:
- You have a qualifying disability.
- Your estate or your beneficiary is making the withdrawal after your death.
- You are purchasing your first home.
If your withdrawal does not meet the requirements to be considered a qualified distribution, it is considered non-qualified. You could be liable for taxes on the earnings income, and you may be assessed an additional 10% penalty as well.
The following situations are considered exceptions to the non-qualified distribution penalty rule. If any of these apply, you may pay taxes on the earnings income but you will avoid the penalty.
- College expenses for you or your family members that meet certain requirements. Note that under some circumstances, family members can include children and grandchildren.
- First time home purchase (up to $10,000) for yourself, your children, or your grandchildren.
- You set up a series of substantially equal payments for a period of at least five years or until you are 59 ½, whichever is longer.
- You are paying for medical expenses that exceed 7.5% of your adjusted gross income. Note that these expenses cannot be reimbursed to you in some other way, such as through health insurance.
- You must pay health insurance premiums as a result of losing a job.
- You are taking a distribution as a result of an IRS levy.
- You are taking a qualified reservist distribution.
- You are taking a qualified disaster recovery assistance distribution.
Disclosure
Nothing in this article should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This article is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome. Financial advisory services are only provided to investors who become Wealthfront clients.
This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.