Understanding Roth IRA Early Withdrawal Rules

Understand Withdrawal Rules of Roth IRA

Understanding Roth IRA Early Withdrawal Rules
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The Internal Revenue Code prescribes limitations on the early withdrawal of Roth IRA investments, which must be understood at the time one opts for this plan. Apparently, these limitations are a disincentive against these plans. However, one must also remember that such limitations exist in case of all retirement plans that allow tax benefits to the investors.

A little details about the basic structure and policy of IRA Roth Plans would be helpful in understanding the conditions for withdrawals.

Roth IRA Plans

ROTH IRA Plans are tax favored personal saving plans wherein the tax benefits are available at the time of distribution or withdrawal. This is different from the traditional IRA accounts where the tax benefit is available at the time of contribution itself. It also means that your contribution to Roth IRA has already been taxed and will not be taxed again. However, the earnings on your contributions can be taxed as your income and also be subjected to a penalty of 10% additional tax unless they qualify for exemption.

Difference between Traditional IRA and Roth IRA Plans

In a TRADITIONAL IRA account, the contribution made to the account is deducted from taxable income. For example, if pre-tax income is $ 50,000 out of which a contribution of $ 4000 is made to IRA, then tax will be payable only on the remainder of $ 46,000. However, when this contribution along with the returns earned by it is withdrawn, it will be treated as income, and tax will have to be paid on it.

In the ROTH IRA, the contribution made to the account is not exempted from tax, but on the other hand, no tax is payable on the original contributions or on earnings from investment, at the time of its withdrawal, provided the conditions and rules prescribed as satisfied.

Rules for Withdrawal from Roth IRA Plan

Withdrawal of Contributions and Earnings are accorded different treatment. Since the contributions come out of income on which has been paid, no further taxes are payable on its withdrawal.

However, there are strict rules govern withdrawal of earning. Withdrawals of earnings from a Roth IRA plan can be of two types. 'Qualified withdrawals' are those which fulfill the necessary rules and hence do not attract any additional tax. 'Early withdrawals' are those which do not fulfill these and hence attract additional tax.

Qualified Withdrawal from Roth IRA Account

A qualified distribution is any withdrawal or distribution from your Roth IRA that fulfills the following conditions prescribed for withdrawal and hence is free from tax on withdrawal.

A. It is made after the 5-year period from the year for which a contribution was made to a Roth IRA, and

B. The withdrawal or distribution is made in one of the following conditions.

  1. paid on or after the date you reach age of 59 1/2 years, OR
  2. paid because you are disabled, OR
  3. paid to a beneficiary or to your estate after your death, OR
  4. withdrawn (only once in lifetime) to acquire a residence, if you have not owned any residence during the previous 24 years, the amount is less than $ 10,000.

Early Withdrawal from Roth IRA Account

Early withdrawals are those that do not satisfy the above conditions of a qualified withdrawal, and hence attract tax on withdrawal, as well as an ADDITIONAL TAX of 10 % on the withdrawal as well on any earnings attributable to those withdrawals. The amount of non-qualified withdrawals that are to be included in the income of that year is a somewhat complex process, but can be done by following the Worksheet 2-3 in Publication No. 590 of IRS.

Conditions when Additional Tax on Early Withdrawal is Not Payable

There are some exceptions in which additional tax of 10% on early withdrawal will not payable. These include the following (in addition to the conditions prescribed for qualified withdrawals).

  • The distributions are part of a series of substantially equal payments.
  • You have significant unreimbursed medical expenses.
  • You are paying medical insurance premiums after losing your job.
  • The distributions are not more than your qualified higher education expenses.
  • The distribution is due to an IRS levy of the qualified plan.
  • The distribution is a qualified reservist distribution, or a qualified disaster recovery assistance distribution or a qualified recovery assistance distribution.

Withdrawals from Roth IRA accounts converted from IRA plans before 5 years from the year of conversion or before the age of 59 1/2 years will also attract the additional tax of 10%.

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Thus, Roth IRA plans place strict restrictions on early withdrawals in the form of additional tax of 10%.

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