What Happens If I Take Money from My Roth IRA Early?
Roth IRAs are popular with people who expect to fall in a higher income tax bracket during retirement than in the present year, because of the after-tax savings they permit. However, if you take money out early, you may have to pay income taxes and penalties on the withdrawal.
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What Is an Early Distribution?
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Roth IRAs have two different stipulations that must be met before you can remove money as a qualified distribution. If you do not meet both stipulations, your withdrawal will be considered an early distribution, potentially subject to taxes and penalties. The first is the same as traditional IRAs: you must be at least 59 1/2 years old. The second is that the account must have been open for five tax years. The tax age of the account is figured by counting from January 1 of the first tax year contributions were made. For example, even if you made your 2007 contribution as late as February 15, 2008, you would count the age of your Roth IRA from January 1, 2007.
Contributions or Earnings?
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The tax implications of taking money from your Roth IRA early depend on whether your withdrawal constitutes contributions or earnings. Contributions come out first, but once the contributions have been exhausted, earnings must be withdrawn. For example, if you have a $40,000 Roth IRA with $28,000 of contributions and $12,000 of earnings and you took a $30,000 early withdrawal, you would have $28,000 of contributions and $2,000 earnings.
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Tax Treatment
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Contributions made to your Roth IRA can be taken out early with no tax implications. This is because Roth IRA contributions are made with after-tax dollars; you do not receive a tax deduction for the contributions. Earnings, on the other hand, are taxable and subject to an additional 10 percent income tax penalty. However, you can avoid the early withdrawal penalty if an exception applies, such as using the money for college expenses or medical expenses that are greater than 7.5 percent of your adjusted gross income.
Reporting Your Early Withdrawal
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Whenever you take money out of your Roth IRA early, even if it is just contributions, you must report it on your income taxes using form 1040 or 1040A. The financial institution that you have your Roth IRA with will send you a form 1099-R that shows you how much you took out and how much of that is taxable. On form 1040A, you enter the taxable portion on line 11b and the nontaxable part on line 11a. On form 1040, the taxable portion goes on line 15b and the nontaxable portion on line 15a. If you are taking out earnings, complete form 5329 to calculate your early withdrawal tax penalty.
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