Skip to Content
Investing Specialists

Pulling Money From Your Roth IRA? Read This First

Roth withdrawals can be tax- and penalty-free, but not if you don't play by the rules.

When it comes to withdrawals, there's an awful lot to like about Roth IRAs.

First, flexibility: Because you contribute aftertax dollars to a Roth IRA, you can pull out your contributions at any time or for any reason without incurring a penalty--even if you withdraw your contribution shortly after you made it and even if you're younger than 59 1/2. That flexibility is a key reason I often recommend a Roth IRA as a good multitasking vehicle for investors who are conflicted about whether to stash money in their emergency funds or save for retirement. The ability to withdraw contributions makes the Roth a decent vehicle for both tasks.

Roth assets are especially valuable during retirement, as owners can take tax-free distributions. Used alongside traditional IRA assets, withdrawals from which are taxed at ordinary income tax rates, Roth accounts give retirees at least some ability to control their tax bills in retirement. Nor are Roth assets subject to required minimum distributions, making them ideal receptacles for wealthier retirees who would like to earmark assets for their heirs.

Despite those attractions, however, it would be a mistake to assume that Roth withdrawals never have any strings attached. In order to take tax- and penalty-free withdrawals, a Roth IRA owner must meet two tests. First, the account owner must be 59 1/2, disabled, or using the money (but only up to $10,000) to pay for a first-time home purchase. You often hear that you can take tax- and penalty-free withdrawals after death, which is a bit of a head-scratcher; that means, though, that your heirs can take tax- and penalty-free withdrawals after your death. Note that we're talking about tax- and penalty-free withdrawals of investment earnings here; as noted above, you can always withdraw your contributions without any strings attached.

Additionally, Roth IRA owners must meet what's called the five-year rule, meaning that the assets must have been in the account for at least five years for the account owner to be able to take tax- and penalty-free withdrawals of the whole Roth IRA. What's tricky is that there are two sets of five-year rules--one that applies to money that got into a Roth because of a direct contribution to a Roth account and another that applies to Roth assets that were converted to Roth from traditional.

Five-Year Rule for Contributions
The five-year rules for direct Roth IRA contributions are actually pretty generous. If you contributed assets directly to a Roth IRA, your five-year clock starts on the first day of the tax year for which you funded the IRA. Say, for example, you squeaked in a 2016 IRA contribution in April 2017, just under the wire to make one for the 2016 tax year. In that case, your five-year clock started on Jan. 1, 2016--even though your contribution didn't actually get into the account until 16 months later. Assuming you meet the other tests (you're older than 59 1/2, disabled, or buying a first-time home), you'd be able to take tax- and penalty-free withdrawals on Jan. 1, 2021.

What if you've opened multiple Roth IRAs with multiple providers, or you've been making annual contributions to a Roth? Here again the five-year rule allows for a lot of wiggle room: Your initial Roth IRA contribution starts the five-year clock--additional contributions, or separate Roth IRA accounts you've set up later or with other providers, don't affect your five-year window. Roth 401(k) assets, on the other hand, have their own five-year clocks, distinct from the five-year clock that applies to Roth IRA assets. In addition, as Michael Kitces notes in this blog post, each Roth 401(k) is subject to its own separate five-year holding period.

Five-Year Rule for Conversions
When it comes to assets that you've converted to Roth IRAs--rather than contributed directly--the good news is that taxes won't apply if you end up needing to withdraw the funds that you've converted. That's because you've already paid taxes on that money at the time of conversion.

However, you could still be subject to a 10% penalty if you need to withdraw the converted amounts (on which you paid taxes at the time of the conversion) prior to age 59 1/2 or before five years have elapsed since the conversion.

In contrast with the five-year rule for IRA contributions, where all of your Roth IRAs get lumped together for the purpose of your five-year clock, separate five-year holding periods apply to pools of assets that you've converted to Roth IRAs at various points in time. Assets converted in 2015 will be eligible for penalty-free withdrawals in 2020, assets converted in 2016 can be withdrawn penalty-free in 2021, and so on.

You can get around the penalty in certain situations outlined here--for example, if you're using the money for qualified education or medical expenses. And if you made additional contributions to the Roth after converting, you can withdraw those amounts at any time and for any reason, just as if you had contributed to any other type of Roth account.

Whether that additional penalty applies depends on the nature of your IRA at the time you did the conversion, and hinges on the Internal Revenue Service's ordering rules for distributions, as laid out in IRS publication 590. If you're taking a withdrawal from a Roth, the IRS assumes that contributions are withdrawn first (and are always tax- and penalty-free), followed by the taxable portion of a conversion, followed by the nontaxable portion of a conversion, followed by investment earnings.

Note the language above; the penalty only applies to the converted amounts on which you've paid taxes during the conversion process. For example, say you had a $100,000 rollover IRA that you set up when you left your old firm, which you in turn rolled into a Roth IRA in 2013. If you wanted to withdraw that money before turning 59 1/2, you'd have to wait until 2018 to tap that $100,000 penalty-free. Because you owed taxes on your whole IRA amount at the time of conversion, that amount will be subject to the 10% penalty if withdrawn before five years have elapsed.

If you converted a traditional IRA that consisted of nondeductible and deductible contributions, things get even trickier. Say, for example, you've built up $15,000 in a traditional IRA, $10,000 of which consists of your own nondeductible contributions and $5,000 of which is deductible contributions. When you do the conversion, you'll owe tax on the $5,000 (money on which you never paid taxes). If in three years you need to withdraw $5,000, before you're 59 1/2, that amount will be subject to penalty because the IRS assumes that the amount withdrawn first is the taxable portion of your rollover--in this case, $5,000. Withdrawing the other $10,000 wouldn't trigger a penalty, however.

Backdoor Roth IRA investors can usually avoid the 10% penalty because all or nearly all of their converted amounts will consist of money they have already paid taxes on and they'll owe next to nothing in taxes at the time of conversion. For example, say you put $5,000 into a money market account in a traditional nondeductible IRA in March 2016 and converted shortly thereafter, with your balance still at $5,000. Because none of your conversion amount was taxable--you had already paid tax on the money and you hadn't gained anything--you could turn around and withdraw that amount without owing a penalty or taxes, even if you weren't 59 1/2 and hadn't met the five-year holding period.