Investing your savings in a Roth IRA rather than another type of retirement account generally allows you access to more of your money sooner in life, without paying taxes or penalties. Your withdrawals might trigger a tax or a penalty under some circumstances, however. Some simple rules can help you determine whether your Roth IRA distributions will be tax-free or not.
- You can always withdraw your original contributions from your Roth IRA tax-free.
- Earnings can be withdrawn tax-free if you are at least age 59 1/2 and you've had your Roth for five years or more.
- Withdrawals of earnings are also tax-free if you are disabled, you inherited the Roth, or you use the distribution to buy or rebuild a first home.
- Any funds that are considered income when you convert to a Roth IRA incur a 10% penalty tax if you withdraw them less than five years after the conversion.
Are Roth IRA Distributions Tax-Free?
Your withdrawal from a Roth IRA isn't taxable under three circumstances:
- You withdraw no more than the amount of your original contributions, regardless of your age.
- You're age 59 1/2 or older and you've had your Roth for five years or longer, measured from the first day of the year in which you established and contributed to it.
- You're under age 59 1/2 and you've had your Roth IRA for five years or longer, but you're taking the distribution because you're disabled, you're the beneficiary inheriting the Roth, or you meet an exception because the distribution is being used to buy or rebuild a first home as described in IRS Publication 590-B (Early Distributions, Exceptions section).
Roth IRA contributions are made with after-tax dollars. You can't take a tax deduction for them at the time you make them. Therefore, you can withdraw your contributions at any time without paying tax again.
When Are Roth IRA Distributions Taxable?
- You haven't met the five-year rule for opening the Roth and you're under age 59 1/2. You'll pay income taxes and a 10% penalty tax on earnings you withdraw as of 2022. The 10% penalty can be waived, however, if you meet one of eight exceptions to the early-withdrawal penalty tax.
- You haven't met the five-year rule, but you're over age 59 1/2. Distributed earnings will be included as income and subject to income taxes, but they won't be subject to the 10% penalty tax.
- You've met the five-year rule, but you're not yet age 59 1/2. Earnings withdrawn—but not contributions—will be considered income and will be subject to income taxes and a 10% penalty tax. The 10% penalty can be waived if you meet one of the exceptions listed in IRS Publication 590-B.
These rules apply only to earnings, which aren't treated the same as contributions or conversion amounts.
Example No. 1
Suppose Sally is 58, and she opens her first Roth with a contribution of $6,000. She also converts $50,000 from a traditional IRA to this Roth IRA. Sally reaches age 60 with a Roth IRA worth $60,000 two years later. She cashes it all in to buy a motorhome.
Sally pays no tax on her $6,000 in contributions, and she pays no income tax or the 10% penalty tax on her $50,000 from conversions because she already paid tax at the time she converted. She has no penalty because she is over age 59 1/2. She only pays income tax on the $4,000 that is attributable to earnings because she hasn't met the five-year rule.
None of the distribution would have been taxable if the account owner had taken out only the amount of original contribution and conversion funds. The earnings could be left for another few years, when the owner could have withdrawn those funds tax-free.
Example No. 2
John is 58, and he's had a Roth IRA for more than five years, with a balance of $20,000. His original contributions totaled $10,000, and last year, he converted $8,000 from a traditional IRA to his Roth. Another $2,000 of his Roth is from investment gains. John cashes in his entire Roth IRA.
John pays no tax on the first $10,000 of his distribution because he's withdrawing his original contributions. He pays a 10% penalty tax on the next $8,000 of his distribution because it's been less than five years since the conversion.
He pays income tax and a 10% penalty tax on the last $2,000 of distribution, which is all investment gains, because he doesn't meet the dual requirements of the five-year rule and, being over age 59 1/2, and he doesn't qualify for any exemptions. He would pay no tax on this portion of the distribution if he were over age 59 1/2.
He would pay income tax, but not a penalty, on this portion of the distribution if he were over age 59 1/2 but hadn't met the five-year requirement.
Conversions vs. Earnings
Your distributions are deemed to occur in a specific order when you take them from a Roth IRA, depending on whether they're contributions, conversions, or earnings.
This order of distributions is intended to keep people younger than age 59 1/2 from taking a regular IRA, converting it to a Roth, then taking a distribution the next year, thereby circumventing the traditional IRA early-withdrawal penalty.
Regular contributions are distributed first. These come out tax-free, regardless of age or the length of time that's passed since you opened the Roth.
Conversion and rollover amounts are distributed on a first-in, first-out basis. The taxable portion that you would have been required to include in gross income at the time of the conversion is distributed first. The non-taxable portions of conversion/rollover amounts are next.
Conversion or rollover amounts that are subsequently distributed can be subject to the 10% penalty.
A five-year clock begins running when you convert funds to a Roth, and any amounts that you had to include in income at the time of the conversion and that are withdrawn before the five-year period is up are subject to the 10% penalty. This penalty does not apply to distributions from Roth conversions that occur after age 59 1/2.
Roth 401(k)s, called "designated Roth accounts," work a little differently. Not all of these rules would apply if you have money in a Roth 401(k) at work.
The Bottom Line
Like any retirement account, it's important to do your best to keep the money invested as long as you can. The longer your money can stay invested and grow, the better off you will be. Talk to a financial planner first to see how it will impact your future if you plan to use your retirement funds for a major purchase.
Frequently Asked Questions (FAQs)
Do Roth IRA distributions count as income?
As long as you are qualified, your Roth IRA distributions will not count as income. To qualify, you must be over the age of 59 1/2 and the account must have been open for at least five years, although there are some exceptions.
How much are distributions from a Roth IRA taxed?
When you withdraw from a Roth IRA before the account is five years old and/or you are below the age of 59 1/2, you may be required to pay a 10% penalty fee and regular income taxes on the amount.