Roth IRA Early Withdrawal Penalties, Revisited

A reader named Bill recently asked for clarification on the details surrounding Roth IRA early withdrawal penalties. I’ve talked about this in the past, but with the end of the year looming, I thought it would be good to touch on it again.

As with traditional IRAs, the IRS views all of your Roth IRAs (assuming that you have more than one) as a single pot of money. And within this pot, there might be multiple types of money: contributions, conversions, and earnings.

The first (and perhaps most important) point to make regarding Roth IRA withdrawals is that the IRS makes certain assumptions about the order in which the different types of money are taken out.

When you take money out of your account, you are assumed to first be accessing your original contributions. Once that money is deplete, you are assumed to be accessing money that you converted into the account. And finally, once the other amounts have been depleted, you are assumed to be accessing any investment earnings.

This is really just fancy bookkeeping, but it works to your advantage. The reason I say this is that you are allowed to withdraw your Roth IRA contributions (money that you contributed directly to your Roth, subject to annual contribution limits) at any time with no taxes or penalties. This makes sense since you’ve already paid taxes on this money.

For money that you converted from a traditional IRA to a Roth IRA, the treatment is similar — as long as you don’t touch the money for at least five years after completing the conversion. If you do withdraw this money within five years, you’ll have to pay a 10% penalty. The point here is to discourage people from using a Roth IRA conversion as a means to access money in their traditional IRAs.

But once the five year rule has been met, funds that you converted to your Roth IRA can be withdrawn without any taxes or penalties. Again, this makes sense because you will have paid any taxes due when you made the conversion.

And finally, for any subsequent earnings within your Roth IRA… Well, any earnings that are withdrawn within five years of establishing your Roth IRA are subject to income taxes. Moreover, if you’re younger than 59.5, the withdrawal will also be subject to a 10% penalty unless an exception applies.

Once you hit age 59.5 and the account is at least five years old, you can withdraw your earnings tax and penalty free. Otherwise, assuming none of the aforementioned exceptions apply, you will face taxes plus a 10% penalty.

The exceptions mentioned above include distributions made to a beneficiary after your death, disability, or using the funds to pay certain costs associated with being a first-time homebuyer.

For more details, check out IRS Publication 590.