If you’re looking for a tax-advantaged way to save for retirement, a Roth IRA may fit the bill. With a Roth IRA, qualified withdrawals made after age 59½ are 100 percent tax- and penalty-free. But what if you need to tap those funds a little earlier? Will you be subject to Roth IRA withdrawal penalties?
Ordinarily, early withdrawals of your earnings (not your contributions), would be subject to a 10 percent penalty. However, there are some scenarios in which you may be able to avoid it. Here’s a look at when and how you can withdraw money from a Roth IRA without being penalized.
Qualified Distributions vs. Non-Qualified Distributions
The IRS distinguishes between qualified and non-qualified distributions when determining whether to apply a penalty to Roth IRA withdrawals.
To count as a qualified distribution and avoid the 10 percent penalty, your Roth IRA must have been open for at least five years. The distribution must also meet certain criteria. Aside from being able to make penalty-free withdrawals after age 59½, you can also avoid the penalty for these three reasons:
1. You’re totally and permanently disabled.
If you become disabled and can no longer work, the IRS allows you to withdraw money from your Roth IRA, regardless of age, without paying the 10 percent tax penalty. Just be aware that your plan administrator may require you to provide proof of disability before signing off on a penalty-free withdrawal.
2. You’re inheriting a Roth IRA from someone else.
Inheriting a Roth IRA from someone else—be it a spouse or another relative—falls under the qualified distribution umbrella, according to the IRS. If you’re the person who’s leaving a Roth IRA behind for someone else, your estate also wouldn’t have to pay the penalty if the distribution is made before you would have turned 59½.
3. You’re buying a first home.
If you need some cash to cover the down payment or closing costs on a first home, you could withdraw some of your earnings from a Roth IRA without a penalty even if you’re under age 59½. The IRS does limit penalty-free distributions to $10,000. To qualify for the first-time buyer exception, the money must be used to pay any associated costs before the close of the 120th day after you receive it.
Exceptions to the 10-Percent-Penalty Rule
Anything from the Roth IRA withdrawal that doesn’t meet the definition of a qualified distribution is a non-qualified distribution. That doesn’t mean, that you have no chance to escape Roth IRA early withdrawal penalties. The IRS gives you some leeway for making penalty-free withdrawals if:
4. You’re taking a distribution to pay unreimbursed medical expenses.
If you have out-of-pocket medical expenses that you need to cover, you may be able to get around paying the additional tax penalty on Roth IRA distributions. To qualify, your unreimbursed medical expenses must exceed 10 percent of your adjusted gross income (7.5 percent if you or your spouse was born before Jan. 2, 1952).
5. You need to pay your health insurance premiums while you’re unemployed.
You could also avoid the tax penalty if you’re using some of your Roth IRA savings to maintain your health insurance premiums because you’re unemployed. The IRS will waive the penalty if you lost your job, you received unemployment compensation for at least 12 consecutive weeks, you took the distribution the same year you received unemployment or the next year, and you received the distribution no later than 60 days after going back to work.
6. You’re using the money for qualified higher education expenses.
A college degree is pricey these days. If you’re footing the bill for education expenses, your Roth IRA may be a valuable source of funding. It’s possible to avoid the 10 percent penalty if you’re using Roth IRA assets to pay for qualified education expenses for yourself, your spouse or your child. Qualified education expenses include tuition, fees, books, supplies and equipment required for enrollment. Room and board is also covered for students who are enrolled at least half-time (there are specifics about how much you can spend).
7. You’re taking substantially equal payments from the plan.
In some cases, you may need to make regular withdrawals from a Roth IRA before age 59½, instead of taking a single lump-sum distribution. If you’re taking periodic distributions of the same amount, the 10 percent penalty wouldn’t kick in. The IRS can use one of three methods to determine the amount of the payments you’re entitled to receive and the payments must be spread out over five years.
8. The withdrawal was due to a tax levy.
If you have unpaid federal taxes, the IRS can draw on your Roth IRA to pay the bill. The 10 percent penalty won’t apply if the IRS levies the money directly. If, on the other hand, you withdraw the money and use it to pay your tax bill, you’d have to pay the penalty if you don’t meet the qualified distribution guidelines.
9. You’re a qualified reservist.
The final exception applies to active duty military members. If you’re called to active duty, you can withdraw money from your Roth IRA without fear of a penalty.
Remember to double-check the Roth IRA withdrawal rules and consult a tax professional before taking money out of your account. Making sure that you’re meeting the requirements for a penalty-free withdrawal is a must for preserving the rest of your retirement assets.