Back in 2010, many taxpayers with traditional IRAs, were given the opportunity to convert to a Roth IRA, which grows tax-free. Now those same taxpayers under the age of 59 1/2, may want to withdraw funds from their Roth IRA without paying tax or facing a penalty, which is possible.
What are the rules for withdrawing from a Roth IRA early?
The tax code indicates that the potential tax liability and penalty is based on specific order withdrawal rules. For instance, contributions are counted first, then taxable rollover conversions, then nontaxable rollover conversions and finally the earnings.
You can always withdraw contributions free of any tax liability or penalty. If you converted from a traditional IRA to a Roth IRA, the conversion amounts are free of taxes and penalties if five calendar years have passed since the conversion date. For instance, if you converted in 2010, you would need to wait until 2015 to withdraw the conversion amount to avoid taxes and penalties. Also note that partial conversions are counted separately and each lot has its own five-year holding period with the oldest conversions counted first. If you absolutely need the converted monies now or before the five year probationary period, you can still withdraw it without being subject to taxes but there will be a 10% penalty.
If your Roth IRA is in a gain position, then the earnings will be subject to tax and a 10% penalty will be assessed. For instance, if you liquidated your entire Roth IRA account with a value of $75,000 and an original basis of $40,000, the $35,000 gain would be subject to ordinary income tax and a 10% penalty. There are exceptions though. For instance, first-time home buyers can withdraw up to $10,000 in earnings from a Roth IRA without facing the 10% penalty. If you’ve had the IRA for over five years, then the earnings will also be exempt from taxes.
More Questions? Browse Answers or ask your IRA tax questions online.
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