What are the rules for when a taxpayer takes distribution from a Roth IRA before they are retired? For example, can a person planning for retirement withdraw contributions at any time before 5 years and reaching 59 1/2 years of age or are they also subject to 10% penalty on a Roth IRA distribution?
What happens if I withdraw contributions or principal from the Roth IRA after only 5 years? How are the earning distributions addressed by the IRS?
Answer addressing what happens when withdrawing principal from Roth IRA?
With a roth account you are allowed to withdraw your contributions tax free at any time. The total of your contribution is considered your basis. If you have contributed $8k over the life of the roth IRA, you can take $8k in distributions without any taxes or penalties.
If you want to withdraw more than the amount you have contributed during the lifetime of the account, you begin to start withdrawing earnings. There are two rules which will apply to withdrawal of earnings specifically:
The first rule is known as the 5 year rule, which means if you have not had the roth IRA open for 5 tax years, you will owe ordinary income taxes on any earnings withdrawn. This means you will owe federal and state taxes at you marginal tax rate on any earning that do not meet the 5 year rule. If you have had the roth IRA open beyond 5 years, you will not owe any ordinary income taxes on the withdrawal.
The second rule you will deal with when withdrawing from a Roth IRA is an early withdrawal penalty (10%) for taking a retirement account distribution before being aged 59 1/2. This penalty will only apply on any earnings you withdraw and will not apply to return of basis (contributions) as mentioned previously. A taxpayer can avoid this early withdrawal penalty if you qualify for certain exceptions (disability, first time home buyer, qualified education expenses, irs levy, etc).
The only type of contribution that cannot be withdrawn at any time from your Roth without tax or penalty is a rollover from a 401k, which must season for 5 years first, and may then be withdrawn without tax (which you paid when you rolled) or penalty.
Taxes wouldn’t be owed when withdrawing from the Roth IRA since it had already been paid on a regular 401k rollover, but the 10% penalty may apply if done within five years and the person is less than 59 1/2 or doesn’t qualify for one of the exclusions (SEPP, disability prior to distribution, used for higher education, and several other options).