Many people don’t understand the impact of a Roth IRA early withdrawal. Before making any decisions about early withdrawals, it’s essential that investors learn about the IRS rules for this action. Here’s everything Roth IRA account holders should know about early withdrawals.
In this article:
- Order of Early Withdrawals From Roth IRAs
- Roth IRA Early Withdrawal Penalty and Taxes
- Additional Penalties
- Roth IRA Early Withdrawal Exceptions
Roth IRA Early Withdrawal Rules to Keep in Mind
Roth IRA Definition: Roth IRAs are special retirement accounts to which one makes post-tax contributions from their income, which are not tax-deductible.
Order of Early Withdrawals From Roth IRAs
Ideally, all retirement accounts would be left alone so that funds could continue to accrue for one’s retirement. However, financial circumstances sometimes arise that make the idea of taking an early distribution appealing.
The IRA considers all Roth IRAs as one entity when it comes to withdrawals. Any distributions must be withdrawn in a specific order regardless of which Roth IRA they’re going to use for disbursement:
- Non-taxable annual contributions, outside of conversion amounts, to a Roth IRA
- Conversion contributions completed on a first-in, first-out basis
- Any earnings
A person might be tempted to make the withdrawals differently for convenience. Taking that action may result in penalties levied against them by the IRS.
Roth IRA Early Withdrawal Penalty and Taxes
Early Withdrawal Penalty
The IRS typically charges a 10% penalty for early withdrawal in a Roth IRA if one takes distributions from taxable funds before they reach the age of 59 ½. The idea is to keep a person from using up all their savings before retirement.
One can look for a Roth IRA early withdrawal calculator online to determine just how much they will end up owing on their estimated distribution. The IRS also views the amount as additional income. That amount gets added on top of the amount they’re withdrawing.
Taxes for Non-Qualified Distributions
The 10% penalty isn’t the same thing as taxes on non-qualified distributions, which is a regular income tax. This depends on how much the account holder plans to take out of the IRA:
- Amounts above contributions — Any amounts exceeding the contributions are subject to income taxes. That means they’re making withdrawals against the earnings on the account, which are considered to be additional income.
- Amounts within the contributions — If they take out an amount that doesn’t go over that limit, it won’t be subject to income tax.
One loophole to Roth IRA early withdrawal penalties is if they take out contributions made in the same year.
- Say that the account holder contributes $2,000 during a calendar year that generated $200 in earnings.
- The account holder can take out the entire $2,200 without incurring a penalty if it is done before the date tax filing is due.
There are also penalties that apply when taking early withdrawals from conversion contributions from a Traditional IRA to a Roth IRA. Account holders will have to pay a 10% penalty on those distributions for failing to keep those converted amounts in the Roth IRA for the five-year tax period after the initial conversion, as required by the IRS.
Roth IRA Early Withdrawal Exceptions
- Distributions made in the event of a disability to the Roth IRA owner. However, investors should check first with the limitations set by the IRS on what is considered a disability. They can do so by reviewing IRS Publication 590 and IRS Code Section 72(m)(7).
- Those made after the death of the IRA owner.
- Distributions made as a series of equal payments over the expected lifespan of the owner of the IRA.
- Those used to pay for any uncovered medical expenses that are more than 7.5% of the adjusted gross income (AGI) of the Roth IRA owner.
- Distributions made to cover the costs of insurance premiums once a Roth IRA owner has received payments for unemployment compensation longer than 12 weeks.
- Those used to cover the costs of purchasing a home for the first time. The amount can’t exceed $10,000 throughout the Roth IRA owner’s lifetime.
- Distributions used to cover qualified education expenses for either the Roth IRA owner or any eligible family members.
- Those made to cover back taxes due to an IRS levy placed against the person’s IRA.
Having a thorough understanding of Roth IRA early withdrawal rules can prevent someone from being subject to unnecessary penalties.
It’s ideal for investors to evaluate first if the reasons for taking out the funds are worth the taxes and penalties they may be subjected to. One way to help in deciding this is to ask oneself if the distributions under consideration are worth the possibility of limited funds left for retirement.
What are your thoughts about the Roth IRA early withdrawal rules? Share them in the comments section below.
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