Are Roth IRA Withdrawals Taxable?

When Are Roth IRA Withdrawals Taxable?

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Investing your savings into 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 and penalties. Your withdrawals might trigger a tax or a penalty in some circumstances, however. Some simple rules can help you determine whether your Roth IRA withdrawal will be tax-free or not.

Are Roth IRA Withdrawals Tax-Free?

Your withdrawal from a Roth IRA won't be taxable under three circumstances:

  1. You withdraw no more than the amount of your original contributions, regardless of your age.
  2. You're age 59½ 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.
  3. You're under age 59½ 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've made them. You can therefore withdraw your contributions at any time without paying tax again.

When Are Roth IRA Withdrawals Taxable?

Your Roth IRA withdrawals might be taxable if:

  • You haven't met the five-year rule for opening the Roth and you're under age 59½. You'll pay income taxes and a 10% penalty tax on earnings you withdraw as of 2021. 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 59½. Earnings withdrawn will be included as income and subject to income taxes, but they won't be subject to the 10% penalty tax.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 59½. Earnings withdrawn—but not your contributions—will be considered income and are subject to income taxes and a 10% penalty tax.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. Earnings aren't treated the same as contributions or conversion amounts.

Example No. 1

Let's say that Sally is 58, and she opens her first-ever 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 59½. She only pays income tax on the $4,000 attributable to earnings because she hasn't met the five-year rule.

None of the withdrawal would have been taxable if the account owner had taken 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.

He pays no tax on the first $10,000 of his withdrawal because he's withdrawing his original contributions. He pays a 10% penalty tax on the next $8,000 of his withdrawal 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 withdrawal, which is all investment gains, because he doesn't meet the dual requirements of the five-year rule and being over age 59½, and he doesn't qualify for any exemptions. He would pay no tax on this portion of the withdrawal if he was over age 59½.  

He would pay income tax, but not a penalty tax, on this portion of the withdrawal if he was over age 59½ but hadn't met the five-year rule.

Conversions vs. Earnings

Your withdrawals 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.

Regular contributions are withdrawn 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 withdrawn on a first-in, first-out basis. The taxable portion which you would have been required to include in gross income at the time of the conversion is withdrawn first. The non-taxable portion of conversion/rollover amounts are next.

Conversion or rollover amounts that are subsequently withdrawn can be subject to the 10% penalty tax.

This order of withdrawals is intended to keep people younger than age 59½ 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 tax.

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 clock is up are subject to the 10% penalty tax. This 10% penalty doesn't apply to distributions from Roth conversions that occur after age 59½.

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 are. 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.