LAST REVIEWED May 01 2020 9 MIN READ
By The Human Interest Team
Roth IRAs can be excellent ways for individuals to save for retirement, especially those who routinely contribute and follow the rules set forth by the Internal Revenue Service (IRS). However, like any benefits the IRS gives taxpayers, changes and adjustments may happen in the future. For this reason, account owners must understand how Roth IRA plans work and their distribution rules.
Roth IRA Distribution Rules
Roth IRA distribution rules are usually more lenient than their 401(k) and traditional IRA counterparts in regards to when withdrawals need to start and for what purposes. However, account owners still want to do their homework before withdrawing funds from their Roth IRA. If specific requirements aren’t met, account owners could end up with a 10% early withdrawal penalty and owing taxes.
Roth IRA withdrawal rules may differ depending on whether the account owner is taking out their contributions or their investment earnings. Contributions are the funds account owners deposit into their IRA, while investment earnings are the profit gained from the contributions to the account. Both of these income sources grow tax-free in the account.
Account owners over the age of 59 1/2 can withdraw contributions from a Roth IRA for any reason and, at any time, penalty-free. Those younger, however, will face a penalty if they withdraw investment earnings early without a qualifying reason. Account owners using funds from another type of account that are converted into a Roth IRA need to wait a minimum of five years before removing those funds without penalty.
The IRS has several exceptions that allow account holders to make a Roth IRA withdrawal without facing a penalty. A popular reason is buying your first home. Homebuyers may still qualify as first-time homebuyers even if they’ve owned a home previously.
Qualified vs. Non-Qualified Distributions
If the Roth IRA account owner meets the five-year rule for withdrawals, any withdrawal is considered a qualified distribution as long as it meets one of these conditions:
The account owner is 59 1/2 or older.
If the account owner is purchasing their first home, up to $10,000 can be withdrawn.
If the account owner has a disability or has passed away, it’s easier to qualify for an exception.
Unless an account owner qualifies for an exemption, distributions not meeting the qualified distribution requirements may face extra penalties and fees.
When Can You Withdraw From a Roth IRA Without Penalty?
Withdrawing investment earnings from a Roth IRA too soon can result in the account owner being hit with a 10% early-withdrawal penalty and income taxes on those funds. However, some situations allow account owners to avoid both of these. In addition to the conditions mentioned above, other exceptions can be made. Valid situations include:
Account owners use funds for qualified higher-education costs for themselves or eligible family members.
Account owners use funds to reimburse themselves for medical expenses exceeding 10% of their adjusted gross income.
Account owners become unemployed and need to use funds to pay for health insurance premiums.
Account owners agree to Substantially Equal Periodic Payments (SEPP) for five years or until they become 59 1/2, whichever happens last.
Account owners have an IRS lien placed against their plan.
The Roth IRA Five-Year Rule
Many individuals understand the tax savings they can receive by investing post-tax dollars into a Roth IRA. However, not realizing all of the Roth IRA distribution rules can foil their withdrawal plans, especially the Roth IRA five-year rule.
The Roth IRA five-year rule states that five years from the tax year of an account holder’s first contribution need to pass before they can withdraw the investment earnings from their account tax-free. Jan. 1 of the year they made their first contribution to their account starts the clock for the five years. This rule applies to everyone, even if the account owner is 107, buying their first home, or deceased.
Roth IRA Withdrawal Timeline
It’s essential to understand when you can withdraw funds from your Roth IRA and what taxes and penalties you may face, if any. Account owners can withdraw contributions they made to their Roth IRAs anytime without paying any taxes or penalties. However, they may have to pay penalties and taxes on investment earnings they withdraw from their Roth IRA depending on their age and length of time they’ve had the account.
Roth IRA Distribution Rules For Account Owners Under 59 Years Old
Account owners wanting to withdraw investment earnings from a Roth IRA they’ve owned for less than five years the funds are subject to penalties and taxes. Account owners may be able to avoid the penalties but not the taxes in some situations, including:
They use the funds, up to a lifetime maximum of $10,000 for a first-time home purchase.
They use the funds to cover qualified education costs.
They become disabled or pass away.
They use funds to reimburse themselves for approved medical expenses.
They are unemployed and use funds to pay for health insurance premiums.
Account owners who have had the Roth IRA for five years or longer can withdraw funds tax-free if one of the conditions mentioned above is met, or the distribution is made as a SEPP.
Roth IRA Distribution Rules For Account Owners 59 1/2 to 70 Years Old
If the account owner has had the Roth IRA for under five years, investment earning withdrawals are subject to taxes, but no penalties. Account owners can withdraw investment earnings from Roth IRAs they’ve owned for five years or more without having to pay taxes or be subject to penalties.
Roth IRA Distribution Rules For Account Owners 70 1/2 Years Old and Older
The same Roth IRA distribution rules apply for account owners 70 1/2 years old or older as above. However, unlike traditional IRAs, there are no Required Minimum Distributions (RMDs) once the account owner reaches age 70 1/2.
Roth IRA Distribution Rules for Account Owners of Any Age
If an individual transfers a Roth or traditional IRA and requests the check be made payable to them, they can do a non-taxable rollover. This allows them 60 days to contribute those funds to another IRA without penalties or taxes. This can be done once time during a 12-month period.
Let a retirement savings specialist from Human Interest help you better understand Roth IRA distribution rules and make sure you’re not hit with unexpected taxes and penalties on withdrawals.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.