Reviewed or updated February 11, 2018
Rules for tax-free distributions from Roth IRAs.
In most cases the best strategy is to leave as much money in your IRA as you can, and for as long as you can. But if you need early access to that money, you’re generally in better shape with a Roth IRA than with a traditional IRA. You’re allowed to withdraw your regular contributions at any time without paying tax or penalty. This is not the case for the earnings, however. Unless you meet the tests described below, a withdrawal of earnings will be taxable — and may be subject to a penalty as well.
Terminology: When you put money into an IRA, you’re making a contribution. When you take money out, you’re making a withdrawal, and you’re receiving a distribution. The words “withdrawal” and “distribution” mean the same thing and are used interchangeably.
Withdrawing your contributions
The rules for Roth IRAs permit you to do something that isn’t allowed for traditional IRAs: withdraw the nontaxable part of your money first. If you have after-tax dollars in a traditional IRA, distributions come proportionately from pre-tax and after-tax dollars. But when you take money out of a Roth IRA, the first dollars you take out are considered to be a return of your regular contributions. You don’t have to meet any special tests to receive those dollars free of tax. You can take them out any time, for any reason, without paying tax or penalties.
When you apply this rule, you treat all of your Roth IRAs like a single big Roth IRA.
Example: Suppose you have a Roth IRA with a balance of $2,500 (a $2,000 contribution and $500 of earnings) and another Roth IRA with a balance of $3,000 (a $2,000 contribution in a different year and $1,000 of earnings). You can withdraw the entire $3,000 from the second Roth IRA without paying tax, even if you don’t meet the tests to withdraw earnings tax-free. Your other Roth IRA will now be treated as if it has $1,000 of contributions and $1,500 of earnings.
There’s an exception to the rule that contributions come first when you withdraw money from a Roth IRA. When you withdraw excess contributions (contributions that are not permitted, or contributions that are larger than permitted) you may be required to withdraw earnings attributable to those contributions.
In a way, you might consider it a disadvantage to be able to take money out of a Roth IRA so easily. Remember, the best way to grow your investments is to keep as much as possible in your Roth IRA as long as possible, so it will continue to earn investment income tax-free. You may find it hard to resist the temptation to take money out of your Roth IRA — and later regret that you withdrew the money.
If you receive a distribution of earnings from your Roth IRA, you’re required to pay tax (and possibly penalties) unless you received a qualified distribution. A qualified distribution is a distribution that satisfies two tests: a five-year test and a type of distribution test. It’s not enough to meet just one of these; both are necessary.
The five-year test is satisfied beginning on January 1 of the fifth year after the first year you establish a Roth IRA. If you established a Roth IRA in 2017, for example, any distribution from a Roth IRA will satisfy the five-year test if the distribution occurs on or after January 1, 2022.
The five-year test is satisfied on January 1 even if you establish your Roth IRA late in the year. In fact, you’re treated as if you established your Roth IRA in the previous year if you make the contribution on or before April 15 and designate it as a contribution for the previous year.
When you meet the five-year test for one Roth IRA, you meet it for all Roth IRAs. For example, suppose you contributed $500 to a Roth IRA in 2017. Three years later you decided to set up another Roth IRA and contribute $2,000. Both IRAs will meet the five-year test on January 1, 2022.
Type of distribution
Even after you meet the five-year test, only certain types of distributions are treated as qualified distributions. There are four types of qualified distributions:
- Distributions made on or after the date you reach age 59½.
- Distributions made to your beneficiary after your death.
- If you become disabled, distributions attributable to your disability.
- “Qualified first-time homebuyer distributions.”
A distribution of earnings that fails to meet these tests will be taxable, and may be subject to the 10% early distribution penalty as well.