The Roth IRA distribution rules allow tax and penalty-free withdrawals before age 59 1/2. This assumes you have not already withdrawn more than the total of your past yearly Roth IRA contributions.
This part is easy. You may withdraw the value of your previous contributions at any time with no tax or penalty. You don’t need a good reason, and you don’t need to be age 59 1/2.
From there, things get a bit more complicated.
When you withdraw money from your Roth IRA, the Roth IRA distribution rules deem it is taken out in a particular order. If you have more than one Roth IRA, for accounting purposes the IRS looks at it as one big account, so it doesn’t matter which account(s) contributions were made to or where money is withdrawn from.
This aggregate “account” contains your past yearly contributions, any funds you may have converted from a traditional IRA or employer-sponsored retirement account, and hopefully lots of earnings generated from your investments.
You can withdraw an amount up to the value of your past contributions at any time, for any reason, completely free of tax and penalty. You don’t have to wait 5 years or be age 59 1/2. It’s that simple.
Example 1: Sofia is 18 and a senior in high school. She worked after school five days a week and made $4,000. As a reward for her hard work, her mom gave her $2,000 to open up and fund a Roth IRA. The value of the account is currently $2,500.
After graduation, and according to the Roth IRA distribution rules, Faye can withdraw $2,000 tax and penalty free to take a backpacking trip across Europe with her loser boyfriend.
Example 2: Craig, who is 58, has been contributing to his Roth IRA for years. Through shrewd investing, his $20,000 worth of contributions grew to $190,000. Craig can only access his $20,000 of contributions tax and penalty free right now. He’ll have to wait at least another 1 ½ years (age 59 1/2) to access his $170,000 of earnings tax and penalty free.
If you’ve converted funds to your Roth IRA in the past, the Roth IRA distribution rules state this money gets tapped next when a withdrawal is made.
Depending on where your money was converted from, it was either taxable or non-taxable at the time of the conversion. Each type has its own set of rules and come out in this order:
After exhausting all of your previous contributions and converted funds, earnings are the last to come out. In order to escape the 10% early withdrawal penalty, earnings must be considered “qualified,” which means one or more of the following events have happened:
In order to escape tax as well as the penalty, withdrawals of earnings must also satisfy the five year rule, which is different than the five year rule for converted funds. This five year rule simply states that your Roth IRA must have been open for at least 5 years.
If you have multiple Roth IRAs, count from the date you opened the first one to see if you satisfy this rule.
Under the Roth IRA distributions rules, the 10% penalty will be avoided for withdrawals under the following exceptions. Remember, just because the penalty is avoided doesn’t mean you won’t pay tax – it may or may not be owed (see the IRS Ordering Rules above):
In order to avoid having to understand these incredibly complex Roth IRA distribution rules, as well as accumulating lots more tax free earnings, leave the money in your Roth IRA alone until retirement!