Know These Rules Before You Dip Into Your Roth IRA

Investing, IRA
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By Christopher Allen

Learn more about Christopher on NerdWallet’s Ask an Advisor

When can you withdraw money from your Roth IRA — and will you have to pay taxes and penalties when you do?

These are common questions for holders of Roth IRAs, the popular individual retirement accounts that allow after-tax contributions to grow tax-free and be withdrawn tax-free, if certain conditions are met.

Roth IRA distribution rules

There are two main conditions you must meet in order to withdraw money from your Roth IRA tax-free: qualified distribution rules and the five tax-year rule.

A qualified “distribution” — which is another way of saying withdrawal — from a Roth IRA must meet at least one of the following criteria. It should be:

  • Taken on or after you reach age 59½
  • Made to your beneficiary or estate after you die
  • Made to you after you become disabled (within the IRS definition)
  • Used to pay for specific first-time homebuyer expenses

In addition, the account holder must have made the initial contribution to the fund at least five tax years — not calendar years — before the distribution.

Unless both sets of rules are met, the distribution will not become qualified, and the earnings will be subject to tax, and perhaps penalties.

The early withdrawal penalty doesn’t apply to your IRA contributions (the money you put into the account) — just earnings (the amount the account grows, on top of your contributions). You can withdraw your contributions without penalty at any time.

Exemptions from early-withdrawal penalties

Early withdrawals — those that don’t meet age or the five-tax-year holding period requirements — are considered nonqualified and are subject to taxes on earnings and possible penalties, but there are exceptions.

For example, withdrawals that don’t meet holding period requirements, but otherwise would be considered qualified distributions — that is, they occur once the owner is 59½, after he or she has died or become disabled, or fund a first-time home purchase — aren’t penalized or taxed.

Early withdrawals that meet one of the following criteria are also exempt from taxes and penalties. These include withdrawals that:

  • Are a series of “substantially equal periodic payments” made over the life expectancy of the IRA owner
  • Pay for unreimbursed medical expenses that exceed 7½% of your Adjusted Gross Income (AGI)
  • Pay medical insurance premiums after the IRA owner has received unemployment compensation for more than 12 weeks
  • Pay qualified higher education expenses for the IRA owner and/or eligible family members
  • Pay back taxes because of an IRS levy placed against the IRA

Withdrawal rules in the real world

Here’s an example that will illustrate how early Roth IRA distributions work:

Let’s say John opened a Roth IRA and contributed $3,000 to it in the tax year 2010, when he was 24. Now it’s January 2016, and he wants to withdraw his entire account balance, $5,500. It’s made up of the $3,000 initial contribution and $2,500 in earnings.

John can withdraw the money, but his reasons for withdrawing it will determine whether he pays taxes or penalties.

If John wanted the $5,500 for a down payment on a new car, it would not be qualified distribution, even though he’d have met the five-year requirement. Therefore, he’d be subject to income taxes and a 10% early withdrawal penalty on the $2,500 in earnings.

It’s important to note that John could take $3,000 — his actual contribution — out of his Roth IRA without taxes or penalties.

But if John were withdrawing the $5,500 to purchase his first home, he wouldn’t be subject to any taxes or penalties on either his contributions or earnings, because first-time home purchases are exempt from early withdrawal penalties or taxes. Visit the IRS site for further insights into the details of qualified distributions from a Roth IRA.

>> MORE: How much can I invest in a Roth IRA account?

Roth IRAs offer flexible withdrawals, which is generally most attractive to young adults whose financial needs can change very quickly. However, making unqualified distributions can be costly. If you’re hoping to take earnings out of your Roth IRA, have a quick talk with a financial professional to ensure you fully understand your options.

Christopher Allen is a financial advisor with Parkworth Capital Management in Raleigh, N.C.


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