By: Clay Wyatt
When you play your cards right, a Roth IRA plan offers tax-free growth on your retirement investments. In order to realize the full potential of this type of plan, you must withdraw funds in accordance with IRS IRA withdrawal rules. Doing so will lead to what is called a qualified distribution. In other words, if the IRS agrees with the purpose and/or timing of your withdrawal, they will stay off your back. Failure to do so has financial consequences. Let's explore Roth IRA withdrawals.
To make Roth IRA withdrawals without paying penalties or additional taxes, the withdrawal must be a qualified distribution. Remember, you've already paid taxes on the money that you originally contributed, so taxation at this point would be double taxation. To ensure that your Roth IRA withdrawals are left alone by Uncle Sam, they must fall under at least one of the following:
- Funds taken out after they have been in the plan for at least 5 years and you are at least age 59 ½.
- Roth IRA withdrawals that are used for the purchase or rebuilding of the first home of you or a qualified family member. Qualified family members include your spouse, children, step-children, a grandchild of you and/or your spouse, and parents or ancestors of you and/or your spouse (see below for definition of first time home buyer)
- Roth IRA withdrawals taken after you have become disabled.
- Roth IRA withdrawals that are distributed to your beneficiaries after your death.
Note that the above are summaries and you want to get technical assistance before using any of the exemptions. For instance, look how IRS defines a first time homebuyer:
First-time homebuyer. Generally, you are a first-time homebuyer if you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.
There are other cases in which you will have to pay taxes on your Roth IRA withdrawals, but not Roth IRA penalties. They are as follows:
- Funds that are paid out using substantially equal payments over 5 years or until you turn age 59 ½, whichever is longer.
- Roth IRA withdrawals for medical insurance premiums after you have become unemployed.
- Roth IRA withdrawals used to pay medical expenses that are in excess of 7.5 percent of your adjusted gross income.
- An IRS levy on the plan that forces a distribution.
- During certain disaster recovery situations.
- Roth IRA withdrawals to pay higher education expenses for you or eligible family members.
- The money is taken as a qualified reservist distribution (for military personnel).
In some other cases, you will have to pay a 10 percent penalty and possibly taxes on your Roth IRA withdrawals. This happens when you make a non-qualified distribution. A non-qualified distribution is any distribution that does not meet the definition of a qualified distribution. This includes the following:
- You are under age 59 ½ and withdraw funds in excess of your contributions, such as earnings.
- You make Roth IRA withdrawals before the funds have been in the account for at least 5 years.
- Any other Roth IRA withdrawals that are made against the rules of qualified distributions.
As you can see, the rules for Roth IRA withdrawals are fairly straightforward. However, during financial emergencies or situations in which you are uncertain as to whether or not to tap into your Roth IRA plan, it is best to consult a retirement financial advisor. Doing so will help put your mind at ease, as nobody really wants the IRS in their lives!
Lose a Fortune on Your 401k Rollover
If you do not do any of these correctly:
- Opt for a distribution rather than direct transfer
- Rollover company stock to an IRA
- Choose to rollover to a Roth IRA
- Rollover to your new employer’s 401k
- Rollover post-tax contributions