About Roth IRA Withdrawal Rules

The Tax Payer Relief Act of 1997 was signed into law Aug. 5,1997. It introduced the Roth IRA within its legislation. IRA contributions had dropped dramatically since the 1986 Tax Reform Act. The Roth was created as a motivator to get American taxpayers investing more toward retirement.

Contribution withdrawals may be taken any time, free of penalty and tax. If you have multiple Roth accounts, the IRS looks at all of those Roth accounts as one big Roth IRA. Therefore, if you had two Roth accounts with contributions totaling $5,000 and earnings totaling $2,500 for the two accounts, you could withdraw all $5,000 of your contributions free of tax and penalties. This ease of withdrawing funds certainly makes the Roth advantageous, but a disadvantage in that it may be too easy to access money that should be reserved solely for retirement.

Since Roth contributions are nondeductible, withdrawals are not included in your gross income. However, account owners must meet two qualified distribution tests in order to get capital earnings free of tax and penalties. First, the account must be established for a minimum of 5 years. The 5-year period begins January 1 of the year you make your first contribution and ends January 1 five years later. Second, your withdrawal must be a qualified distribution.

Earnings may be withdrawn after the first 5 years, tax-free and penalty free, if meeting one of the following qualified distributions criteria: disability; distribution of assets to your beneficiary or estate after your death; first-time home qualification of up to $10,000, which can only be done once in a lifetime; or distributions made on or after reaching age 59 1/2. If you take an earnings distribution--still after the 5-year holding period--for one of the following penalty exceptions, you avoid being penalized but will be subject to tax: substantially equal payment distributions; significant unreimbursed medical expenses; paying medical insurance premiums after losing employment; distribution for but not going beyond qualified higher education expenses; paying an IRS levy of a Roth qualified plan, or a qualified reservist distributions.

There is a set order that takes place with contributions, conversions and earnings withdrawals. First, contributions are taken out but are nontaxable because you paid taxes up front. Second, conversions come out on a first-in, first-out basis (FIFO). You won't be taxed on withdrawing conversions, but you will be subject to the 10 percent early distribution tax if the distribution takes place within the first 5 years. And third, earnings are removed last and will be subject to a penalty if the distribution is not qualified or possibly taxed, depending on the exception.