Must-Ask Questions: Roth IRA Withdrawals

May 31, 2022
When retirement is years away, most investors tend to focus more on saving and less on what will happen when it's time to take their money out.

Of course, putting money away for retirement is critical. But it’s just as important to understand the rules for withdrawals—since missteps can cost you. 

"One of the main benefits of a Roth IRA is that you can withdraw your retirement savings without owing additional taxes, as long as you meet some basic requirements," says Hayden Adams, CPA, CFP®, and director of tax planning at the Schwab Center for Financial Research. "Understanding early withdrawal rules and exceptions can help you avoid a penalty and unnecessary tax on your withdrawals."

But Hayden says, "Roth IRAs can be more than just a savings tool. When used as part of a larger retirement withdrawal strategy, they can also give you flexibility and efficiency from a tax perspective that you won’t get with a 401(k), traditional IRA, or brokerage account."

Here are six must-ask questions to help you consider how Roth IRA withdrawals might work for you.

#1: How can I avoid a penalty and taxes on my Roth IRA withdrawals?

When it comes to withdrawals, money you contribute to your Roth IRA is treated differently than earnings (or growth) on investments in your Roth IRA account. You can withdraw contributions at any time without tax or penalty.

But in most cases, you'll need to wait until you turn 59 ½ and have had your account for at least five years to withdraw earnings tax-free. If you withdraw earnings before this time, you may owe a 10% early withdrawal penalty and ordinary income tax.

#2: Are there exceptions to Roth IRA early withdrawal rules for earnings?

Yes, you may be able to withdraw earnings from your Roth IRA before age 59 ½, if you qualify for an IRS-approved exception. But your exact options will depend on whether or not you’ve held the account for at least five years.1 

If you’ve held your Roth IRA account for at least five years, you may qualify for an early withdrawal without taxes or penalty for these reasons: 

  • You use it for a first-time home purchase (up to a $10,000 lifetime maximum)
  • You become disabled 
  • You pass away (and the withdrawal is for your beneficiary)

If you’ve held your Roth IRA account for less than five years, you may qualify for an early withdrawal without penalty for the reasons below. But you’ll still owe ordinary income tax on any earnings you take out before age 59 ½.

  • You use it for qualified expenses related to a birth or adoption
  • You use it to pay for unreimbursed medical expenses or health insurance 
  • You use it for qualified education expenses
  • The distribution is made in substantially equal periodic payments2

#3: Does the five-year rule apply to withdrawals after a Roth conversion?

Yes. If you convert a traditional IRA or 401(k) to a Roth IRA, you’ll need to hold the Roth IRA account for at least five years before making withdrawals to avoid a 10% early withdrawal penalty. The five-year period starts on the first day of the tax year in which you made the conversion. 

 "There are exceptions, but a converted Roth IRA is generally treated as a new account that must be open for at least five years to meet the timing requirement of the tax code," says Hayden.

#4: Why do experts sometimes advise delaying Roth IRA withdrawals?

Aside from age requirements and the five-year rule, experts often recommend delaying withdrawals from your Roth IRA account as long as possible to give your contributions and earnings more time for potential growth. 

"Any tax-free gains you make on investments in your Roth IRA account can help offset the taxes you paid up front," says Hayden. "And the longer you can leave your Roth IRA assets alone, the longer they have to potentially benefit from compound growth."

#5: What are RMDs—and will I need to take them if I have a Roth IRA?

Required minimum distributions (RMDs) are withdrawals the IRS requires you to take from most retirement accounts—and pay taxes on—once you reach age 72. Unlike traditional IRAs or other tax-deferred accounts such as a 401(k), you’re not required to take RMDs from a Roth IRA, which means you can leave your Roth savings invested as long as you choose. 

Hayden says, "Having a portion of your savings in a tax-advantaged retirement account that isn’t subject to RMDs can provide critical flexibility that may help you withdraw your retirement savings in a more tax-efficient way over time. And if you don’t use your Roth IRA funds for retirement, you can pass them along to your heirs so they can benefit from tax-free withdrawals."

#6: How do withdrawals from an inherited Roth IRA work?

A Roth IRA must have been open for at least five years for heirs to make tax-free withdrawals. Once the five-year rule is met, the rules for inherited IRA withdrawals get a bit more complicated. But based on changes set forth by the SECURE Act of December 2019, most heirs have a few options for taking the money out depending on the type of beneficiary they are and when the original owner of the account died. 

Generally, the IRS treats a Roth IRA withdrawal made more than five years after the first tax year in which you made a contribution (including earnings) as a "qualified distribution." This means it is not taxable or subject to a penalty as long as you satisfy one of these qualifying conditions: You’re at least 59½, you become disabled or pass away, or you use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.

Schwab does not currently perform these substantially equal periodic payment (72(t)) calculations. You should speak with a tax advisor. Find more information on these calculation methods in IRS Revenue Ruling 2002-62.

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