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3 Withdrawal Rules You Should Know About Roth IRA | personal finance

(Stefon Walters)

Roth IRAs are great tool for saving and investing for retirement. Unlike a 401(k), your contributions to a Roth IRA are after-tax, so you get the back-end benefits (whereas your tax benefits for traditional) after your money has had a chance to grow and become tax-free. IRAs are up front with a chance for deductions).

However, Roth IRAs also have withdrawal rules that differ markedly from a 401(k) and traditional IRA. Here’s what you need to know.

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1. Withdrawal of contributions is not taxed or penalized

Roth IRA withdrawal rules it largely depends on the “type” of money you withdraw. You can withdraw your contributions – but not your earnings – at any time, for any reason, without paying taxes or penalties. This is because you already paid income tax on the money you contributed before you put it into your Roth IRA. Contributions are the money you deposit into the account and earnings are gains from your investments.

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When you withdraw money from your Roth IRA, it is considered to come in a certain order:

  1. personal contributions
  2. Money converted from a 401(k) or traditional IRA
  3. Earning

Let’s say you contribute $6,000. Roth IRA and earns $4,000, bringing the account value to $10,000. If you withdraw $8,000, $6,000 will be considered a contribution and $2,000 will be considered a winning.

2. How does the five-year rule affect the taxation of earnings?

Earnings from your investments in your Roth IRA are subject to different withdrawal rules. If you want to withdraw earnings from your account without incurring income tax or early withdrawal penalties, you must be at least 59 1/2 years old, and must be at least five years since your first contribution to the account (regardless of your age). If you are 70 years old and made your first contribution three years ago and withdraw your earnings, you will owe taxes on this amount.

The five-year countdown begins on January 1 of the year you made your first contributions. For example, if you make the contribution on June 1, 2022, you must wait until January 1, 2027. You also have until April 15 to make contributions for the previous year, which may affect your timing. If your first contribution for the 2021 tax year is March 1, 2022, you must wait until January 1, 2026 for your five-year timer to expire.

3. How do qualified and unqualified distributions work?

The IRS allows some exceptions to its withdrawal rules, known as qualifying distributions. Qualifying distributions are tax-free and penalty-free after meeting the five-year rule regardless of your age.

Withdrawals meet the qualifying distribution requirements if:

  • Removed due to a permanent disability.
  • Made on or after the day you turn 59 1/2 years old.
  • It is given to a beneficiary after your death.
  • Used to buy your first home (maximum amount is $10,000).

Unqualified distributions do not meet the above requirements, but you have a chance to withdraw money if the following conditions apply:

  • For unpaid medical expenses greater than 17.5% of your adjusted gross income.
  • To pay health premiums after losing your job.
  • You use it for adoption or maternity expenses (up to $5,000).
  • For disaster recovery.
  • You are facing an IRS tax.

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