Penalty for Withdrawing From a Roth IRA

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Roth IRAs can give you a leg up on college costs.
Roth IRAs can give you a leg up on college costs. (Image: education image by Anatoly Tiplyashin from Fotolia.com)

Roth IRAs are one of the two main types of individual retirement accounts. Unlike a traditional IRA, contributions made to a Roth IRA are not tax-deductible. The upside of a Roth, however, is that when you tap the account at retirement--age 59 1/2--distributions are tax-free. Roth IRAs also offer a wider array of early withdrawal options, relative to traditional IRAs, but special rules apply.

Retirement

At the retirement age of 59 1/2, you face no penalties or taxes when withdrawing money from your Roth IRA, according to Erin Burt, an editor at Kiplinger's Personal Finance. Because the Internal Revenue Service (IRS) initially taxed the contributions you made to a Roth IRA as earned income, it cannot tax them again when you access them. The added perk is that if you wait until retirement, you can tap the earnings on your Roth IRA tax-free as well.

Withdrawal of Contributions

You can withdraw contributions you made to an IRA at any age, tax-free, as long as you take them out "by the due date of your tax return for the year in which you made the contribution," according to IRS Publication 590 on IRAs. The IRS treats these contributions as if they were never made. If you accumulated any earnings on those contributions, however, the IRS requires that you report them as income for that year.

Early Qualified Distributions

In addition to reaching retirement age, the IRS considers other withdrawal scenarios qualified distributions. The IRS allows penalty-free early withdrawal from a Roth IRA if you are disabled or if you are the beneficiary of an IRA owner who has passed away. While other less common exemptions exist, most people reap the benefit of using Roth IRA funds to pay for qualified higher education expenses, certain first-time home buyer expenses and what the IRS calls "significant unreimbursed medical expenses." The only catch is that any earnings on your contributions that come out early are subject to applicable income taxes. Consult your tax adviser for details specific to your situation.

10 Percent Penalty

If you make an early withdrawal from a Roth IRA that is not a qualified distribution, the IRS slaps you with a 10 percent additional tax penalty. You will need to record non-qualified, early distributions on your tax return, and you are responsible for paying income tax on those amounts, plus the 10 percent penalty.

Ordering of Distributions

The IRS plays fair, however, when handling early, non-qualified distributions. The IRS has ordering rules in place to determine how you are taxed. When you take an early distribution, regular contributions come out first. You do not pay regular income tax on this amount, but you are subject to the 10 percent penalty. The taxable, followed by the non-taxable portion of conversion or rollover amounts come out next. Conversion refers to amounts converted from a traditional IRA to a Roth IRA. Earnings on contributions are considered last when withdrawing money early from a Roth IRA. You must pay regular income tax plus the 10 percent penalty on these amounts.

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