| Roth IRA Withdrawal Rules | |||
|---|---|---|---|
| Your Age | Five-Year Rule Met? | Taxes and Penalties on Withdrawals | Qualified Exceptions |
| 59 ½ or older | Yes | Tax-free and penalty-free. | N/A |
| 59 ½ or older | No | Tax on earnings but no penalty. | N/A |
| Younger than 59 ½ | Yes | Tax and 10% penalty on earnings. You may be able to avoid both if you have a qualified exception. | First-time home purchase Due to a disability Made to a beneficiary or your estate after your death |
| Younger than 59 ½ | No | Tax and 10% penalty on earnings. You may be able to avoid the penalty but not the tax if you have a qualified exception. | First-time home purchase; Qualified education expenses; Unreimbursed medical bills; Health insurance premiums while you're unemployed; Due to a disability; Childbirth or adoption expenses |
Regardless of your age, you can withdraw your own contributions to your Roth IRA at any time, penalty-free. That rule does not apply to any earnings that result from those contributions.
First-Time Homebuyer Exception
Several IRS exceptions let you withdraw money from your Roth IRA without paying a penalty. A primary exception is for first-time homebuyers. Interestingly, you may still qualify as a first-time homebuyer even if you've owned a home in the past.
If you meet the five-year rule, you can avoid taxes on the withdrawal. However, if it's been fewer than five years since your first IRA contribution, you'll pay income taxes on the earnings portion of the distribution.
Withdrawals from a Roth IRA come in a specific order:
- Contributions
- Money converted from another account, such as a 401(k) or traditional IRA
- Earnings
There’s a lifetime cap of $10,000, so it’s a one-time deal for most investors. But because contributions come out first, many investors won't need to dip into their earnings. This means they can avoid taxes.
Once you withdraw the money, you have 120 days to use it to buy, build, or rebuild a home. According to IRS rules, you can also use the money to help a child, grandchild, or parent who meets the first-time homebuyer definition.
The IRS considers you a first-time homebuyer if you (and your spouse, if you have one) haven’t owned a home during the previous two years.
Higher Education Expenses
You can take penalty-free withdrawals from your Roth IRA to pay for higher education expenses at a college, university, vocational school, or other post-secondary educational institution. But you'll still be on the hook for income taxes on the earnings portion. Qualified expenses include:
- Tuition
- Fees
- Books
- Supplies
- Required equipment
- Room and board (if you're at least a half-time student)
The distribution can be used to help out your spouse, children, grandkids, or great-grandkids (and, of course, you). But no matter who benefits, the withdrawal can't exceed your higher education expenses for the year.
Keep in mind that Roth IRAs and other retirement accounts aren't counted as assets on the Free Application for Student Aid (FAFSA). However, withdrawals count as income. That means if you use your Roth IRA to pay for education expenses, it could reduce the amount of financial aid you receive.
Account holders can withdraw up to $10,000 in Roth IRA earnings free of both taxes and penalties for a home purchase as they have held the account for at least five years.
You Can Take a Withdrawal, But Should You?
If money is tight, a Roth IRA withdrawal may be the easy solution. Still, if you can find another way to make ends meet, do so. You'll avoid any potential taxes and penalties and, more importantly, you'll keep your retirement savings intact and on track. You can't repay the money that you take out of your Roth IRA. Once you take a withdrawal, that money and its potential earnings are gone forever.
Roth IRAs boast tax-free growth and tax-free withdrawals on qualified distributions. If you withdraw money, you could miss out on years—or even decades—of tax-free earnings and growth. That, of course, can take a big bite out of your retirement nest egg. This is the biggest drawback of taking an early withdrawal.
Here's a quick look at the pros and cons of taking a withdrawal from your Roth IRA.
Pros
You can withdraw contributions, tax- and penalty-free
You can withdraw earnings under some special circ*mstances
You can avoid paying interest on a loan
Cons
Withdrawing earnings incurs penalties and taxes if you haven't had the account for five years or are under 59½
You can't repay the money
You miss out on future tax-free growth
Required Minimum Distributions (RMDs)
Unlike traditional IRAs, there are no required minimum distributions (RMDs) for Roth IRAs during your lifetime. If you don't need the money, you can leave the account alone. Your contributions and earnings can continue to grow.
And if you've had the account for at least five years, you can leave your Roth to a beneficiary tax-free. This makes the Roth a fantastic wealth-transfer strategy.
Should You Have Cash in Your Roth IRA?
Roth IRAs offer great tax benefits. While you don't get a tax break when you contribute, your contributions and earnings grow tax-free. Of course, qualified withdrawals are tax-free, as well.
Because of the flexible withdrawal rules, many investors like to keep an emergency fund in their Roth IRAs—a small portion dedicated to cash or other low-risk investments, such as certificates of deposit (CDs). Since there is a limit to how much you can contribute to your Roth IRA, it may be a better idea to keep your cash in a non-retirement account.
Take advantage of the Roth IRA's tax-free growth and invest in more aggressive options like mutual funds, exchange-traded funds (ETFs), or a real estate investment trust (REIT) and dividend-paying stocks. These options would be taxed very heavily in a taxable account or one where you pay taxes on growth and distributions like a traditional IRA.
Can You Get Money From a Roth IRA Before Retirement?
Yes, you can withdraw your own contributions from your Roth IRA at any point, penalty-free, regardless of your age. You cannot withdraw the earnings on those contributions before you retire tax- and penalty-free until you turn 59½ and you've had the account open for at least five years.
Can You Use Your Roth IRA as Life Insurance?
Since a Roth IRA transfers to your heirs tax-free, it can be used as a form of life insurance. For individuals just looking to cover their funeral costs, starting a Roth IRA at a young age and continuing to contribute to it should cover their funeral costs and help them in retirement.
Is a Roth IRA the Easiest Retirement Account to Withdraw From?
The Roth IRA is the easiest common retirement account to withdraw from because of the ability to withdraw contributions at any age and the flexibility to withdraw gains before retirement age for certain circ*mstances. Individuals with a health savings account (HSA) can save their receipts for qualified medical expenses and withdraw from their account at any time, which can make the account easier to withdraw from than a Roth IRA. While far less common, individuals with a 457 plan or a Roth 457 plan have even more withdrawal flexibility than people with a Roth IRA. After they leave the job that sponsored the 457 (usually state or local government work) they can take money out of the 457 plan with no penalties but income tax. If they have a Roth 457 plan they can take money out at any time after separation, for any reason, with no taxes or penalties.
What Is the Roth 5-Year Rule?
Roth IRA rules stipulate that five years must have passed since the tax year of your first Roth IRA contribution before you can withdraw the earnings in the account tax-free.
The Bottom Line
The financial implications, such as taxes, penalties, and loss of future earnings, can make an early withdrawal from your Roth IRA a bad idea. Of course, if you have no other options, it can be comforting to know that your Roth is there for you.
It’s always a good idea to check with a qualified financial professional before making any big decisions about Roth IRA withdrawals. But if you pay close attention to the rules listed above, you’ll be well on your way to a solid withdrawal plan that protects your assets while allowing your retirement cash to take care of your family.
