If you’re confused about the rules and tax treatment for making withdrawals from your Roth IRA, below are answers to some of the most frequently asked questions. Of course, you really should try to avoid touching your Roth IRA. There are incredible benefits to be had for just letting it grow. But if you must dip into it for any reason, these common questions and answers should help you.
1. What are the rules for a Roth IRA withdrawal?
At first glance, this might seem like a question for which there should be a simple answer. But there isn’t one straightforward answer because the nature of the withdrawal can take you down different paths. You’ll understand what I mean as you read some of other questions below. But to help keep things organized in your mind, bear in mind that there are 3 withdrawal levels:
– Personal cash contributions
– Qualified distributions
– Non-qualified distributions
Each has its on characteristics. Read on.
2. How much taxes will I pay on Roth IRA withdrawal?
The amount of taxes that you will pay for making withdrawals from your Roth IRA will depend on several factors including:
- What money you withdraw – As an example, you’ll never pay taxes on the personal contributions that you make into your Roth IRA. Take that money out any time you want. But you will pay taxes on any investment profits that you withdraw early.
- Your age – If you’re age 59.5 or older, ALL the withdrawals you make from your Roth will be tax-fee (including investment profits). But not so if you withdraw investment profits prior to reaching this age.
- Income tax bracket – There are multiple federal income tax brackets. So, the higher your tax bracket, the more you’ll pay in taxes. Keep in mind that your Roth IRA withdrawals will be combined with all your other income sources when calculating your federal and local taxes.
- Timing of the withdrawal – Again, this touches on your age. But it also depends on whether the withdrawal is considered to be a qualified or non-qualified distribution. If it’s qualified, you won’t pay any income taxes, but if it’s non-qualified you’ll likely have to pay standard income taxes and a tax penalty on top.
3. What is a qualified withdrawal from a Roth IRA?
If a withdrawal is qualified, it means that you won’t have to pay income taxes or the 10% additional tax penalty on the money. For a withdrawal to be qualified, it means that you made the first contribution to your Roth at least 5 years ago….And the withdrawal is associated with one of the following…
- You being a first time home buyer
- You becoming disabled
- You reaching age 59.5 or older
- You dying and transferring the money to a beneficiary or your estate
All other withdrawals are considered as non-qualified and subject to regular taxes and the additional tax penalty. Again, remember that we’re talking about investment profits.
4. How much is the penalty for early withdrawal of Roth IRA money?
As mentioned above, you’ll have to pay standard income taxes and an additional 10% tax penalty.
5. How do I make a withdrawal from my Roth Ira?
Taking money out of your Roth IRA is no big deal. You can withdraw it any time you want. Just call the institution that manages your IRA and tell them you want to make a withdrawal. You may have to fill out a form to authorize the transaction.
But after that, they’ll politely cut a check or make a wire transfer for the amount you want. And just in case you’re wondering, you will receive instructions at the end of the year for reporting the withdrawal on your tax return. And, yes, the IRS will also be made aware of any withdrawals that are taxable.
Now, your real question might be, “How to make an EARLY withdrawal from a Roth IRA?” The answer is the same as above. No one is going to hold your money hostage. Just be aware of the tax consequences and potential penalties.
6. How do I report a Roth IRA withdrawal? and How to report EARLY withdrawal from Roth IRA?
Both of these questions lead to the same answer. And I assume that you’re referring to reporting the withdrawal on your income tax return to the IRS.
When you make withdrawals from your Roth IRA, the financial institution that holds your account, has an obligation to provide both you and the IRS with documentation related to any distributions. You should get a special 1099 form from them at the end of year reflecting this activity.
You’ll also receive instructions on how to report the 1099 information on your tax return. If you don’t include the withdrawal on your tax return, the IRS will know.
7. What is a first-time home purchase Roth IRA withdrawal?
If you have not owned a home in the last two years, then you would qualify for a first time home purchase withdrawal from your Roth IRA. The IRS rules allow you to withdraw up to $10,000 from your Roth IRA to buy a home without paying any income taxes or being penalized.
Also, if you’re married, and your spouse has not owned a home for at least two years, they can also withdraw up to $10,000, thereby making it a combined total of $20,000. But there is one significant limitation.
The $10,000 tax-free amount is a LIFETIME maximum for you. What I mean is that you can qualify as a first time home buyer multiple times over your life. But any and all withdrawals you make from your Roth IRA over the years to buy a primary residence cannot exceed $10,000 in total. So if you withdraw $5,000 to buy a home now, that leaves another $5,000 that can be used to purchase another residence years down the road.
As you can see, there are many aspects to the Roth IRA. And the rules are structured to encourage you to make it part of your long term investment and retirement plan. If you’d like to learn more about the Roth IRA, visit this link, What Is a Roth and Who Qualifies?