A Roth IRA offers a tax-advantaged way to save in addition to—or in place of—an employer-sponsored retirement plan. While there’s no deduction for Roth IRA contributions, qualified distributions from a Roth account are tax free. Savers can also withdraw their original contributions on a tax-free basis. There are, however, some scenarios in which taking money from a Roth IRA before age 59½ could have tax consequences.
- A Roth IRA is a tax-advantaged retirement savings account that allows for tax-free qualified distributions.
- Savers can withdraw their original contributions from a Roth IRA without a tax penalty.
- A 10% early withdrawal penalty may apply to non-qualified distributions from a Roth IRA.
- There are some exceptions to the early withdrawal penalty rule that may allow savers to avoid the 10% penalty.
Roth IRA Withdrawal Rules
Roth IRAs, like traditional individual retirement accounts (IRAs), are designed to be used for retirement. Like traditional IRAs, a Roth IRA allows you to save up to a maximum annual contribution limit each year. For 2022 that limit is $6,000, with an additional $1,000 catch-up contribution allowed for savers 50 and older.
However, Roth IRAs differ from traditional IRAs on a few key points:
- Required minimum distributions (RMDs) do not apply in the account holder's lifetime.
- There is no tax deduction for contributions.
- Your ability to contribute is determined by your filing status and adjusted gross income (AGI).
- Qualified withdrawals are tax free.
So what constitutes a qualified withdrawal? According to Internal Revenue Service (IRS) rules, qualified distributions are any payments that are made after the five-year period beginning with the first tax year for which you made a contribution to a Roth IRA for one of these reasons:
- You reach age 59½.
- You become totally and permanently disabled.
- You’ve died and the money is being paid to your IRA beneficiary or estate.
- You’re withdrawing up to $10,000 for the purchase of a first home.
Distributions of regular contributions from your Roth IRA aren’t taxable either. That also goes for distributions that are rolled over into another Roth IRA, assuming that you choose a direct rollover, in which the trustee of your old account transfers money to your new account for you.
If you contribute money to a Roth IRA—but withdraw that same amount by the tax filing deadline for the same year in which you put the money in—it’s like the contribution never happened.
When Roth IRA Distributions Are Taxable
Under IRS rules any non-qualified distributions from a Roth IRA may be subject to a 10% tax penalty. Non-qualified distributions are withdrawals that don’t meet the requirements listed in the previous section. Earnings on non-qualified distributions may also be subject to ordinary income tax. There are, however, some exceptions to this rule based on how long your account has been open and when you take distributions.
If you are under age 59½ and your account is less than five years old, earnings may be subject to taxes and penalties. However, you may be able to avoid the 10% early withdrawal penalty if you’re taking a distribution for:
- Purchase of a first home (subject to a $10,000 maximum)
- Qualified education expenses
- Qualified expenses related to a birth or an adoption (subject to a $5,000 maximum)
- Unreimbursed medical expenses or health insurance if you’re unemployed
- Total and permanent disability
- Receipt of substantially equal periodic payments
- Payment to a beneficiary or an estate due to your death
If you’re under age 59½ but your account has been open for five years or more, you can avoid the tax on withdrawals of earnings if distributions are made for any of the same reasons listed above.
If you’re over 59½ but haven’t met the five-year requirement, then withdrawals of earnings are taxable as ordinary income, but you won’t pay any 10% early withdrawal penalty. If you’re over 59½ and have had your Roth IRA for five years or longer, then no taxes or penalties apply.
Converting a traditional IRA into a Roth IRA can allow you to avoid RMD rules, though you will have to pay taxes on the conversion.
Roth IRA Taxable Distribution Examples
Here are some examples of how Roth IRA distributions may be taxable. First, say that you’re 55 years old and opening a Roth IRA for the first time. You make an initial contribution of $7,000 (the $6,000 annual contribution limit plus the $1,000 catch-up contribution limit). You also convert $70,000 you have saved in a traditional IRA to your Roth account.
Once you turn 59½ you decide to withdraw your Roth IRA savings. Because you’ve reached the age milestone, you won’t owe an early withdrawal penalty on the distribution. However, if you haven’t yet reached the five-year mark since opening the account, then you’d have to pay tax on the earnings portion of your withdrawal. This doesn’t include earnings from converted amounts, though, since you would have paid taxes on those at the time of the conversion.
Converted amounts may escape income tax, but can still be subject to the 10% early withdrawal penalty.
Now assume that you opened your Roth IRA at age 54 instead. You made the same initial contribution and rolled over the same amount. Then at age 59½, you withdraw all of the money in your account. At this point the account has been open for five years, so you escape paying any income tax on earnings. You also avoid the 10% early withdrawal penalty, because you meet the age requirement.
This is a simple example, but it illustrates the importance of the five-year rule and choosing the right timing to make Roth IRA distributions. If you’re getting close to the 59½ age cutoff, it could make sense to wait a little longer to take out money to avoid the 10% early withdrawal penalty.
Do You Have to Pay Taxes on a Roth IRA?
Qualified distributions from a Roth IRA are tax-free. You may, however, have to pay income tax and/or an early withdrawal penalty on non-qualified distributions unless you’re eligible for an exception under IRS rules.
What Is the Downside of a Roth IRA?
A Roth IRA doesn’t offer a tax deduction for annual contributions. Your ability to contribute to a Roth IRA may also be limited by your tax filing status and AGI. You also have to adhere to IRS rules to avoid taxes and penalties on distributions.
What Is the Five-Year Rule for a Roth IRA?
The IRS five-year rule for a Roth IRA specifies that your account must be open for at least five years before you can withdraw earnings tax free. This rule is separate from the age 59½ rule, which can mean paying a 10% penalty on early withdrawals.
How Can I Avoid Paying Taxes on My Roth IRA?
You can avoid paying taxes on a Roth IRA by taking only qualified distributions. You can also avoid tax penalties when taking early distributions if they qualify for an IRS exception.
The Bottom Line
Saving money in a Roth IRA could help you to create wealth for retirement that you can withdraw on a tax-free basis later—or save for your heirs, since RMDs are not required in your lifetime. Understanding the tax rules for Roth IRA withdrawals can help you to avoid any missteps that could potentially trigger a tax bill. When choosing a Roth IRA, also pay attention to the range of investment choices available as well as the fees you might pay.