There's a mass of messy information out there about ROTH IRA withdrawals. I read through several leading articles, and the IRS website, and found little information the average person could decipher. So here's the simple scoop about ROTH IRA distributions.
Are ROTH IRA Withdrawals Tax Free?
The good news: most of the time ROTH IRA withdrawals will be tax free. Details below:
- Your ROTH IRA withdrawal will be tax free if you withdraw just the amount of your original contributions, and contributions are always considered to be withdrawn first, with earnings coming out last. (Conversions and rollover amounts are not included in this definition of contributions.) See additional details below.
- If you are over age 59 ½, all withdrawals will be tax-free.
If you are under age 59 1/2 and withdrawing an amount that is not defined as an original contribution, the rules get more complicated, and those rules are discussed later in this article.
First in, First Out - Why ROTH IRA Withdrawals Are Usually Tax-Free
Any time you take a distribution from a ROTH IRA, it follows a first in, first out rule. What's that mean?
It means the first thing you contributed to the ROTH is the first thing to come back out of the ROTH. Your contributions went in first, and they went in after tax, thus they are not taxed when they come back out.
It doesn't matter if you are not yet 59 ½. It doesn't matter if you have had the ROTH IRA for less than five years. Original ROTH IRA contributions come back out tax free at any time. (Different rules apply to amounts converted to a ROTH IRA or withdrawn from a ROTH 401k.)
Example:
Elsie, age 55, opened a ROTH IRA and put in $6,000 in 2009. In 2010 the account was worth $6,300. Elsie took $6,000 out and paid no tax since she withdrew only her original contributions. If Elsie had taken out the entire $6,300 the $300 of investment gain would be subject to income taxes and a 10% early withdrawal penalty tax.
Under What Circumstances Would I Pay Tax On A ROTH IRA Withdrawal?
- If you are under age 59 1/2, and you are withdrawing more than the total of all of your original contributions, then the portion of your withdrawal that is investment gain would be subject to income taxes and a 10% penalty tax.
- If you have funds in your ROTH IRA that were converted from a traditional IRA or rolled into your ROTH from a qualified retirement plan, and it has been less than five years since the conversion or rollover, any conversion amounts withdrawn would be subject to a 10% penalty tax, even though they would not be subject to ordinary income taxes. Any investment gain attributed to those conversion amount would be subject to ordinary income taxes and the 10% penalty tax.
- The five year clock is measured from the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan.
Example:
- John has $20,000 in his ROTH IRA.
- $10,000 of it came from his original contributions.
- He made his first contribution over five years ago.
- Last year he converted $8,000 from a traditional IRA to his ROTH.
- $2,000 of his ROTH is from investment gains.
- John is age 58.
John cashes in his entire ROTH IRA.
- On the first $10,000 of withdrawal, he pays no tax, since he is withdrawing his original contributions.
- On the next $8,000 of withdrawal, he pays a 10% penalty tax since it has been less than five years since the conversion.
- On the last $2,000 of withdrawal, which is all investment gain, he pays income tax and a 10% penalty tax.
You can find additional details about ROTH IRA withdrawals in IRS Publication 590.
