When Can I Take a Roth Distribution? It's All About the Rules

Last week I said that some taxpayers may be forced to take funds from their Roth IRA to pay the income tax due on a Roth IRA conversion. Yes, you can take money out of your Roth IRA. Generally there is no income tax due on a distribution, but if you are under age 59 ½ you may owe the 10% early distribution penalty. Here’s the way it works.

In order for all Roth distributions to be tax and penalty free, you must be at least 59 ½ AND have established any Roth IRA 5 years ago OR the distribution is due to death, disability, or is for a first-time home purchase.

It is more complicated if you are under age 59 ½. All of your Roth IRAs are treated as one big Roth IRA. You have to track three types of funds in your Roth IRAs: 1) your contributions, 2) your conversions, and 3) your earnings.

When you take a Roth distribution, your contributions are the first funds distributed - even if they are in a different account from the one that makes the distribution. Contributions are distributed tax and penalty free.

When your contributions are gone, then you start on your converted amounts; first in, first out. Each Roth conversion has its own 5-year holding period. If the funds are distributed before the 5 years are up for that conversion and you are still under age 59 ½, then you have to pay the 10% penalty on the amount distributed. (If the funds were after-tax funds when they were converted, then there is no penalty.) This means that you could be under 59 ½ at the time of the distribution and not owe a penalty - if the Roth conversion was done more than 5 years ago.

When your contributions and conversions are gone, then you are taking distribution of the earnings on the Roth account. The earnings will be taxable and subject to the 10% early distribution penalty since you are under the age of 59 ½.

Those are the distribution rules in a nutshell. However, we do NOT recommend that you take funds from your Roth account to pay the income tax due on the conversion unless you absolutely have no other way to pay the tax. You will be reducing the amount you have available in retirement and you are losing all of the tax-free compounded interest on what you withdraw. It could be the difference between living comfortably and having to make tough choices about where to cut back on your expenses in retirement.

-By Beverly DeVeny and Jared Trexler

Posted in: beverly deveny,Ed Slott,ed slott ira,financial,IRAs,money,Retirement,Roth Conversions,Roth Distributions,Roth IRAs,savings,Tax Planning