Roth IRA Distributions: Rules And Caveats

2010 March 16
by Kyle Bumpus
from → 401k/IRA

Roth IRA’s are popular retirement accounts offering individuals the opportunity to save money for retirement on their own. Better yet, you can withdraw the earnings from your Roth IRA completely tax-free after age 59 1/2. That’s right, tax free. Simply put, if you’re eligible to contribute and aren’t investing in a Roth IRA, you’re likely doing something wrong.

Unlike Traditional or SEP IRA accounts,Roth IRA contributions can be withdrawn at any time without risk of penalty for early withdrawal. To qualify for a Roth IRA you must meet income guidelines which are determined by your taxable income and tax filing status. For example, in 2010 individuals who have an adjusted gross income of $120,000 or less can contribute to a Roth IRA, with couples adjusted gross income limited to $176,000. These income limits are adjusted yearly according to inflation, so be sure to look up the current income limits before deciding to contribute.

Withdraw Contributions At Any Time

If you qualify for a Roth IRA, it is important you understand distribution rules in order to gain the maximum benefit from your retirement account. The term distribution is essentially the same as “withdrawal” in this case, occurring when you take money out of your retirement account. As stated earlier, you can withdrawal contributions from your Roth IRA at any time without suffering a penalty. It is important to note that only contributions can be withdrawn at any time without penalty: the same does not apply to earnings from money invested.

or example if your Roth IRA balance is $4,000- made up of $3,000 in contributions and $1,000 in earnings, you would be permitted to withdrawal $3,000 at any time without incurring penalties or fees. Should you find yourself in need of money at some point, this could prove to be an important advantage over a Traditional IRA or company 401k plan. The problem with easy access to money, of course, is the temptation to withdrawal money for circumstances that aren’t really an emergency. Don’t sabotage your retirement by withdrawing Roth contributions needlessly.

Tax Treatment of Roth IRA Distributions

How your distributions are taxed depends on whether or not the distribution is qualified or non-qualified. A qualified distribution is one which is income-tax free. A non-qualified distribution comes with a penalty attached. Here are examples of qualified distributions of an account at least five years old (meaning it has been open in your name for at least 5 consecutive years).

  • You are at least 59.5 years of age or older. Don’t ask my why congress chose 59.5 year instead of just 59 or 60.
  • Distributions that are used toward the purchase or rebuilding of a first time home for the account holder or qualified family members. You can take advantage of this loophole at any age; however, there is a $10,000 lifetime limit on this one.
  • Distributions made after the IRA account holder becomes disabled.
  • Distributions made to beneficiaries after the death of the account holder.

Non-qualified distributions may be subject to income tax and/or early withdrawal penalties. Basically, if you are under 59.5 years old and aren’t disabled or dead, you will owe some sort of penalty or tax.

A note on Substantially Equal Periodic Payments on Roth IRAs:

Substantially Equal Periodic Payments are a useful way to gain access to retirement funds penalty-free before official retirement age. You shouldn’t try it with a Roth, however, because due to a peculiar quirk of the tax code, taking SEPP’s actually makes your distributions taxable as regular income, completely defeating the purpose of a Roth to begin with. I wasn’t aware of this until I was doing a little research on SEPP’s recently. Source: http://en.wikipedia.org/wiki/Substantially_equal_periodic_payments

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