Rules for Withdrawing from a Roth IRA

Apart from the retirement plans offered by employers, Individual Retirement Accounts (IRAs) are one of the best retirement savings tools available. IRAs provide tax-free growth on invested assets and many other advantages, depending on the type of IRA.

Qualified Roth IRA Withdrawals Not Subject to Tax

Provided that you are at least 59 and a half years old and that your Roth IRA has been open for at least five years, all withdrawals from your Roth IRA will be tax-free. These types of withdrawals are referred to as “qualified distributions” according to the IRS.

Additional Criteria for Tax-Free Qualified Withdrawals

While the most common condition for taking a qualified distribution from a Roth IRA is that you are under 59 and a half and you have met the five-year requirements, there are several other scenarios in which a withdrawal is considered qualified and therefore tax-free, including:

• If you are disabled
• If the withdrawal is made to your beneficiary or your estate after your death
• If the withdrawal meets the IRS’s specified “first-time homebuyer” requirements (up to a lifetime maximum of $10,000)
• If you are affected by a qualifying disaster (available in certain years)

Note: Tax-free income in retirement is one of the biggest benefits of a Roth IRA. However, unlike traditional IRAs, you do not have to wait until retirement to withdraw your assets penalty-free and tax-free.

Exceptions to the Early Withdrawal Penalty

Some types of withdrawals, while not qualified withdrawals, are considered exceptions to the 10% early withdrawal penalty. Non-qualified withdrawals associated with these exceptions are not subject to the penalty, but the earnings remain taxable. Penalty-free exceptions include:

• If the withdrawal is used to pay for health insurance during unemployment or if unreimbursed medical expenses exceed 7.5% of your adjusted gross income for the year
• If the distribution is made in substantially equal periodic payments

Tax-Free “Return of Basis” Withdrawals from a Roth IRA

Since no contributions to a Roth IRA are tax-deductible like traditional IRAs, most withdrawals from a Roth IRA will not be subject to tax. There is no tax due on any withdrawal from a Roth IRA if the total amount you withdraw is less than the amount you previously contributed, regardless of your age. For example, if your annual contributions total $20,000 over several years and you then withdraw $5,000, there will be no tax due on your withdrawal because it is considered a return of your original contribution.

Note: In tax terms, withdrawing previous contributions is termed “return of basis”.

Taxable Roth IRA Withdrawals

Using the same example scenario mentioned above, if you withdraw an amount greater than the $20,000 you previously contributed to your Roth IRA, meaning you are also withdrawing earnings before reaching age 59 and a half, part of your withdrawal will be subject to tax and a 10% penalty for early withdrawals. The same applies to any withdrawals from a Roth IRA that exceed your basis (contributions) during the first five years of contributing to the account. This rule is commonly known as the five-year rule.

Note: The five-year rule for Roth IRAs is not as straightforward as you might think, as you can meet the five-year requirement in less than five years, according to IRS definitions. To complicate matters further, assets transferred to a Roth IRA follow a separate timeline for the five-year rule. If Roth IRA funds are added through a Roth IRA conversion, these funds must meet the five-year rule separately. Therefore, if you convert a Roth IRA and then withdraw some of those converted funds in the following year, your withdrawal will be subject to tax.

Penalty

Early Withdrawal Penalty of 10%

In addition to the ordinary income tax, an early withdrawal penalty of 10% is assessed on withdrawals made if the account holder has not yet reached age 59 and a half. However, the 10% early withdrawal penalty will only apply to taxable withdrawals. Therefore, any withdrawals that return to the basis will not be subjected to the early withdrawal penalty, even if the taxpayer is under 59 and a half.

Frequently Asked Questions (FAQs)

Can I return the excess amount I withdrew from my Roth IRA to avoid penalties?

The IRS allows for a grace period if you have withdrawn an excess amount from your Roth IRA. This situation is technically treated as a recharacterization, and you have 60 days to put the funds back into a qualified account to avoid penalties.

Can I withdraw money from my Roth IRA regardless of my age being 59 and a half?

You can always withdraw money from your Roth IRA without penalty, even the amount you have already contributed. Any amounts exceeding the amount you deposited will be subject to tax rules and a 10% penalty. However, there are some reasons that fall under exceptions, such as if you plan to use the funds to cover medical expenses or if you are a first-time buyer purchasing a home, to name a few examples.

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Sources:

• IRS. “Traditional and Roth IRAs.”
• IRS. “Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs).” page 31.
• IRS. “Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs).” page 32.
• IRS. “Frequently Asked Questions about Retirement Plans and IRAs.”
• IRS. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs).”
• IRS. “Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs).” pages 31-33.
• IRS. “Rollovers from Retirement Plans and IRA Distributions.”

Source: https://www.thebalancemoney.com/how-different-roth-ira-withdrawals-work-2894490