Preventing a Roth IRA Penalty: Withdrawal Rules Investors Should Know

Understand Roth IRA withdrawal rules and how to avoid penalties.

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Avoid penalties when withdrawing from Roth IRA
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Key Takeaways

  • With a Roth IRA, you can withdraw contributions at any time without penalty 
  • For the earnings on those contributions, however, there is an early withdrawal penalty
  • There are some early withdrawal penalty exceptions, such as buying a home

The Roth Individual Retirement Account (IRA) is one of the best-known tax-advantaged retirement accounts. One reason it’s so popular is because withdrawals are, for the most part, tax-free during retirement. But there is a Roth IRA early withdrawal penalty. And there are a few other rules to keep in mind as well.

Here’s what you need to know about Roth IRA withdrawal rules. 

Is there a Roth IRA early withdrawal penalty?

With a Roth IRA, contributions are made with after-tax money. As a result, it’s important to understand the difference between your contributions and the earnings on those contributions.

The contributions you make can be withdrawn at any time, without penalty and without paying federal taxes. That’s because you paid taxes on that money up front.

However, your earnings are another matter. If you take an early distribution on earnings, you’ll have to pay taxes on the amount, plus a 10% penalty.

The IRS has made it relatively simple, though. When you take an early withdrawal, contributions come out first, and they should be disclosed to you by your custodian.

Are there ways to avoid the Roth IRA penalty on earnings?

Yes. If you’ve held your Roth IRA for at least five years, there are some ways to avoid the early withdrawal penalty as well as taxes on the amount you withdraw. You can sidestep the Roth IRA penalty if:

  • You’re using the money for qualified education expenses.
  • You’re using up to $10,000 to purchase your first home.
  • You’re permanently and totally disabled.
  • You’re the beneficiary of a Roth IRA and the account owner has died.

Do I have to pay taxes on some Roth IRA withdrawals?

It’s possible to avoid the 10% Roth IRA early withdrawal penalty but still pay taxes on the amount you withdraw if:

  • You’re using the money for qualified education expenses.
  • The money is being used for unreimbursed medical expenses that exceed 10% of your adjusted gross income.
  • You use the money for health insurance premiums while unemployed.
  • The money is the result of qualified military reservist distributions.
  • You take substantially equal distributions.
  • You’re taking the distribution as a result of an IRS levy.

Additionally, even if you’re age 59 1/2, you’ll have to pay taxes on the earnings withdrawal from your Roth IRA if you haven’t had the account for at least five years. You need to have a Roth IRA for at least five years to avoid paying taxes on the earnings withdrawals in any situation.

What if I withdraw an excess contribution?

Roth IRA withdrawal rules allow you to get rid of excess contribution amounts without penalty—as long as you take care of it before the tax filing deadline. You also need to withdraw any earnings that resulted from the excess contribution. The earnings will be considered earned income for the year in which the excess contribution was made.

Make sure to check your information to avoid excess contributions, and arrange to withdraw that money before the tax filing deadline if you made a mistake. If you file for an extension, you have until October 15 to make the change.

Must I take required minimum distributions (RMDs) with a Roth IRA?

No. Unlike a traditional IRA, there are no RMDs for Roth IRAs. But if you're the beneficiary of an inherited Roth IRA (see below), you may have to take RMDs.

What are the Roth IRA withdrawal rules for inherited IRAs?

First of all, it’s important to note that the Roth IRA must have been open for at least five years in order to avoid taxes on the earnings. Other than that, there are two basic choices for the distribution of the assets in the account:

  • Lump sum: Receive the money all at once.
  • Ten-year drawdown: A change due to the new SECURE Act eliminates the former Life expectancy method for many non-spouse beneficiaries. You used to be able to calculate RMDs based on your life expectancy, but now you may need to draw down the IRA by the end of the 10th year following the plan owner’s death, with some exceptions. Read more about the SECURE Act for details.

Also, if you’ve inherited an IRA from your spouse, you have a choice that no one else has—you can transfer the IRA to your name and treat it as if it’s your own Roth IRA. From that point, it would be subject to all the regular IRA rules. 

What happens when I roll a 401(k) into a Roth IRA?

If you have a traditional 401(k) and you roll it into a Roth IRA, you’ll need to pay taxes on any untaxed contributions. In general, contributions to a traditional 401(k) are pretax, so when you roll the money into a Roth IRA (where the earnings grow tax-free), you need to pay taxes. On the other hand, if you have a Roth 401(k), you can roll it into a Roth IRA without worrying about taxes.

Can I convert a traditional IRA to a Roth IRA?

Yes, it’s possible to convert a traditional IRA to a Roth IRA. However, you’ll have to pay taxes on contributions that were made pretax, as well as any gains.

Does the five-year rule apply to IRA conversions?

In order to avoid a Roth IRA penalty when withdrawing earnings, you need to observe the five-year rule with Roth conversions. The five-year period starts on the first day of the tax year in which you made the conversion. This applies whether you’re converting a 401(k) or a traditional IRA to a Roth IRA. There are exceptions, but in general, a converted Roth is treated as a new IRA, with a new five-year period established.

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Key Takeaways

  • With a Roth IRA, you can withdraw contributions at any time without penalty 
  • For the earnings on those contributions, however, there is an early withdrawal penalty
  • There are some early withdrawal penalty exceptions, such as buying a home

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