For working professionals saving for retirement, understanding how Roth IRA withdrawals work can help you think about when you can access your retirement savings. Read on to understand the potential pitfalls of Roth IRA withdrawals. Explore how you can efficiently access money held in your Roth IRA. Feel better informed to evaluate whether contributing to a Roth IRA aligns with your goals.
Learning Points
Roth IRA Withdrawals
Roth IRA withdrawals are relatively more flexible than those for traditional IRA or 401(k) plans. In this short piece, we’ll explore the Roth IRA ordering rules for distributions. Keep in mind that we’ll refer to withdrawals and distributions interchangeably.
Evaluating Roth IRA withdrawals can inspire you to reflect on your own financial goals, and how a Roth IRA does, or does not, support your goals.
Because this topic, like so many others in financial planning, intersects with the world of tax, make sure you coordinate with a qualified tax professional.
Framing your financial decisions around your family, lifestyle, or career goals can help you evaluate your decisions based upon what’s most important to you over the long term. Your goals can inform whether you should take an action (or not). Understanding the tradeoffs of your set of decisions can help you evaluate how a decision takes you closer to your goals, or away from them.
Your goals should guide your decisions. A type of investment or account should align with and support your goals. Not the other way around.
With any investment, make the time to understand the rules and restrictions that will apply over the lifecycle of the investment. As a long-term investor, it’s not enough to only research how to “get into” an investment.
When you can accurately understand the benefits and drawbacks of your investments or the type of account you plan to hold those investments in, you’ll be better prepared to make personalized decisions.
Qualified Distributions
A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements:
- It is made after the 5-year period beginning with the first tax year for which a contribution was made to a Roth IRA set up for your benefit; and
- The payment or distribution is:
- Made on or after the date you reach age 59½,
- Made because you are disabled,
- Made to a beneficiary or to your estate after your death, or
- One that meets the requirements listed for first-time home buyers (up to a $10,000 lifetime limit).
So, if you’re over 59½ and have held your Roth IRA for at least five years, you can withdraw earnings with no tax or penalty. This is in addition to the contributions you can withdraw with no taxes or penalties.
If you’re under the age 59½ and take a Roth IRA distribution within five years of the conversion, you’ll pay a 10% penalty unless you qualify for an exception.
The five-year seasoning period for qualified Roth IRA distributions begins for all your Roth IRAs on January 1st of the first taxable year for which the account was initially funded and ends on December 31st of the fifth year.
Roth IRA Withdrawals: Ordering Rules for Non-Qualified Distributions
If you withdraw assets from your Roth IRA that are not a qualified distribution, a portion of it may be taxable. Keep in mind that all your Roth IRA accounts are viewed as a single bucket for tax purposes, particularly as it relates to these ordering rules.
When you need to access your Roth IRA funds, the current order of your withdrawals of non-qualified distributions are as follows [1]:
1. Regular contributions, including your conversion contributions and rollover contributions from a qualified retirement plan.
2. Conversions and rollover contributions, attributable to other than a Roth IRA or non-designated Roth account. These are allocated on a first-in, first-out basis, generally, total conversions and rollovers starting with the earliest year first.
- Taxable (the amount required to be included in your gross income because of a conversion). Distributions allocated to a conversion contribution are treated as coming first from the taxable portion of the contribution.
- Nontaxable
3. Earnings on contributions
Keep in mind that you can disregard rollover contributions from other Roth IRAs from these ordering rules.
With that as an overview, let’s explore these together in more detail below.
1st: Contributions
Your Roth IRA contributions are the first group of Roth IRA withdrawals you can distribute without becoming subject to a penalty or taxes. And so, in an emergency, your Roth IRA contributions can act as a financial buffer of (near) last resort.
Since you paid income taxes on your Roth IRA contributions, you don’t include qualified distributions from your Roth IRA in your gross income. Similarly, you don’t include Roth IRA withdrawals/distributions representing a return of your regular contributions in your gross income either.
The details matter here, and you may have to include parts of other Roth IRA withdrawals in your income though.
2nd: Conversions, Taxable
When you convert your Traditional IRA to a Roth IRA, often referred to as a rollover, you should plan to pay taxes on the converted assets in the year of conversion.
Distributions of those converted amounts – that were already taxed upon conversion – have a 10% penalty if they are not a qualified distribution.
However, there are no penalties owed when distributing converted Roth IRA assets if one of the following applies:
- It has been more than five full years since the year of the conversion; or
- You are at least 59 ½ years old.
The 5-year period used for determining whether the 10% early distribution penalty applies to a distribution from a conversion or rollover contribution is separately determined for each conversion and rollover.
Meaning, each conversion’s five-year countdown starts on January 1 of the year of the conversion. You can keep track of each of your Roth IRA conversions, since each conversion has its own running clock.
The details matter here, and it is not necessarily the same 5-year period used for determining whether a distribution is a qualified distribution.
Aggregation (grouping and adding) rules: Determining the Taxable Portion of Your Distribution
You can determine the taxable amounts distributed (withdrawn), distributions, and contributions by grouping and adding them together as follows:
- Add together all distributions from all your Roth IRAs during the year.
- Add together all the regular contributions made for the year. This includes contributions made after the end of the year, but before the due date of your tax return. Add this total to the total undistributed regular contributions made in prior years.
- Add together all conversion and rollover contributions made during the year.
Conversions, Non-taxable
Conversely the remaining portion of your Roth IRA distribution that doesn’t fit the taxable criteria above, would be categorized as non-taxable.
3rd: Earnings
You can distribute the earnings of your Roth IRA without any penalties or tax if you satisfy the following requirements:
- It has been more than five full years since your initial contribution to a Roth IRA; and
- You are at least 59 ½ years old.
Exceptions to the Early Withdrawal 10% Penalty
There are a set of special exceptions that are not subject to the additional 10% tax/early withdrawal penalty.
If you believe any of the following exceptions might be in your future, it’s good to be aware of them for your own planning. It can also highlight the need for further research and planning. Funding goals efficiently and avoiding unnecessary taxes and penalties can allow you to achieve your goals sooner with fewer headaches along the way.
Keep in mind that even though a non-qualified distribution fits an exception according to the IRS’ requirements, it will still be taxed.[1]
- Age: After the participant/IRA owner reaches age 59½.
- Disability: If you become permanently and totally disabled, you can withdraw funds penalty-free from both Traditional and Roth IRAs.
- Medical Expenses: You can withdraw amounts up to your unreimbursed medical expenses that exceed 7.5% of your Adjusted Gross Income (AGI) in a calendar year.
- Homebuyers: Qualified first-time homebuyers, up to $10,000.
- Birth or Adoption: Distributions up to $5,000 per child for qualified birth or adoption expenses.
- Death: There is no penalty for the IRA beneficiaries to withdraw funds upon the original IRA owner’s death.
- Education: Qualified higher education expenses.
- Medical Health Insurance: Premiums paid while unemployed.
- Disaster Recovery: Distribution up to $22,000 to qualified individuals who sustain an economic loss due to a federally declared disaster where they live.
- Emergency Personal Expense: One distribution per calendar year for personal or family emergency expenses, up to the lesser of $1,000 or vested account balance over $1,000 (provided these distributions have been made after 12/31/2023).
- IRS Levy: If the IRS levies your IRA to satisfy a tax debt, the withdrawal is not subject to the penalty.
- Domestic Abuse Victim: Distribution to a victim of domestic abuse by a spouse or domestic partner, up to the lesser of $10,000 or 50% of account (provided these distributions have been made after 12/31/2023).
- Emergency Personal Expense: One distribution per calendar year for personal or family emergency expenses, up to the lesser of $1,000 or vested account balance over $1,000 (provided these distributions have been made after 12/31/2023).
- Military: Certain distributions to qualified military reservists called to active duty.
This is a general list of exceptions, and the specifics of each exception vary. A simple takeaway from all these rules is that it’s critical to keep track of all your IRA contributions.
Roth IRAs and Required Minimum Distributions (RMDs)
There are no required minimum distributions (RMDs) for a Roth IRA while the original account holder is alive.
Required minimum distributions (RMDs) are the minimum amounts you must withdraw from your retirement accounts, which include traditional IRAs, SIMPLE IRAs, and SEP IRAs, each year.
However, you should plan on taking your required minimum distributions if you have an inherited Roth IRA.
Additional Considerations on Roth IRA Withdrawals
Keep in mind that the Roth IRA income limitations for contributions do not affect your ability to withdraw money from your Roth IRA.
For example, if you had previously opened and funded a Roth IRA and then began earning more than the Roth IRA income limits. However, you’ll want to understand when you can access your Roth IRA funds.
When you follow the rules governing Roth IRA withdrawals, you can avoid the actions that generate penalties and/or taxes. Monetary penalties and taxes can take you away from what you are trying to accomplish with your Roth IRA in the first place.
Taking a Strategic View of Your Finances
Hopefully you found this overview of the Roth IRA withdrawals helpful and educational.
What works well for one person might not be the perfect fit for another.
If you’re interested in learning more about saving for retirement, here are two pieces covering Roth IRAs and Traditional IRAs in 2024.
When you evaluate what type(s) of IRAs best align with your goals, you’ll want to fully incorporate all the moving parts of your financial life into your decision.
When you can take a comprehensive view of your finances, you are better positioned to understand how you can work towards your savings priorities. A more complete view of all the elements of your financial life can also help you evaluate the tradeoffs of funding specific savings priorities relative to others.
The Next Step
Are you on track for your short-term goals, like making memories with your family by going on vacations together? How confidently are you approaching saving and investing for your long-term aspirations, like retiring or pursuing a meaningful second career?
We help busy parents and professionals like you develop financial plans to address questions like:
- How can we save for a fulfilling retirement beyond our 401(k) plans?
- What does it take to save for the kids’ education and make a lifetime of memories along the way?
- These causes are close to our hearts – what are our options to give even more meaningful support?
As your financial planner in Saint Louis, we can help you get organized and start feeling more confident that you are making progress towards your savings priorities.
Working with your financial planner in Saint Louis can provide you with the right mix of accountability, collaboration, and long-term thinking.
When you know who and what are truly important, we can help you create incredible clarity about your spending and savings priorities. Clarity to confidently save for and spend on what matters.
If you’re ready to take the next step together, let’s talk.
Disclosure
This commentary is provided for educational and informational purposes only and should not be construed as investment, tax, or legal advice. The information contained herein has been obtained from sources deemed reliable but is not guaranteed and may become outdated or otherwise superseded without notice. Investors are advised to consult with their investment professional about their specific financial needs and goals before making any investment decision.
[1] Publication 590-B (2023), Distributions from Individual Retirement Arrangements (IRAs). Internal Revenue Service. (n.d.). https://www.irs.gov/publications/p590b/. Accessed: 11/22/2024.