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How to Access Roth IRA Accounts Prior to Retirement

There is a huge, common misconception we hear often from clients with Roth IRA accounts. Most clients understand Roth IRA’s to be retirement vehicles that cannot be accessed prior to age 59.5 without penalty. THIS IS NOT TRUE!! Let’s take a deep dive into Roth IRA accounts to better understand how liquid they can be prior to retirement.

The advantage of the Roth IRA is that you pay the taxes before you contribute, so your money grows tax-free, and no taxes are due on withdrawals. The problem is that the account is considered a retirement account, so there is generally a 10% penalty for early withdrawals before 59 ½. This taxation and penalty, however, only applies to EARNINGS inside the Roth IRA account. Let’s break this down further.

Difference Between Contributions and Earnings

Roth IRA accounts are made up of two features: contributions and earnings. This is best explained through an example. Let’s say 3 years ago, Kim made a contribution of $6,000 to her Roth IRA account. No further contributions have been made. Today, her account is worth $10,000 due to investment returns. Her “basis” in this Roth IRA is $6,000 and her account has $4,000 worth of earnings currently. 

Kim needs a new air conditioning unit for her house but doesn’t have any cash in her savings account. Luckily, her Roth IRA has liquidity features that allow her to withdraw the original contributions to her account without paying taxes or penalties on that money!

The IRS uses a FIFO (First-In, First-Out) accounting method with respect to these accounts. This means that if withdrawals are made, the contributions come out first and THEN the earnings. Those contributions were made with post-tax dollars, so they are fully liquid to Kim to be removed at any time without penalty. In this example, Kim could remove her basis of $6,000 without penalty. The earnings ($4,000) need to remain in the account and are generally subject to an early withdrawal penalty if removed prior to Kim’s age 59.5.

However, there are some situations where Kim can withdraw the earnings in her account before the minimum age without paying the penalty. This can come in handy if you need cash to buy a first home, pay for college, or if your family grows. 


Accessing Earnings Without Penalty

Generally speaking, the earnings inside a Roth IRA account are available after age 59.5. There are some complexities here, however. Let’s take a look.

The Five-Year Rule of Roth Ownership

Roth IRAs have another layer of complexity when it comes to taxes. The account has a five-year holding requirement that applies to earnings on your contributions. Your original contributions are made with after-tax dollars, so no taxes are due on contributions. But if the asset grows, any growth will be subject to taxation if the account is less than five years old. 

The Minimum Age Limit

If you want to withdraw funds before age 59 ½, you'll have to pay a 10% penalty for early withdrawal unless you meet exemption criteria. If you’ve owned the account for less than five years, you will also be liable for taxes on the earnings on money you withdraw. You don’t have to pay taxes on the original contribution you withdraw because you funded the account with after-tax dollars. 

Exceptions to the 10% Penalty Rule if You are Under Age 59 ½ 

You can avoid the 10% penalty for certain specific situations. If you haven’t met the five-year rule, you’ll still owe taxes on earnings. 

Inherited Roth IRA

The SECURE Act made changes to how beneficiaries are treated. Surviving spouses and minor children, beneficiaries who are not more than ten years younger than the deceased, and children who are chronically or disabled do not have limits on the amount of time to withdraw the funds. Anyone else inheriting a Roth IRA must distribute all the assets in the account within ten years of the original owner's death. 

This is a brief overview – the rules here are fairly complicated, and there are strategies to follow depending on your age, the age of the account, your relationship to the original owner, and your tax situation.

Unemployed and Need to Pay Medical or Healthcare Expenses 

If you become unemployed, you can access funds to pay for unreimbursed medical expenses or health insurance premiums.

Home Purchase Exemptions

If you’re buying your first home or you haven’t owned a home as your primary residence in the last two years, you don’t need to pay the penalty if you withdraw earnings for the purchase. You don’t have to be the buyer – it can also be a spouse or a family member, and you can withdraw the funds from your account. It’s not just for home purchases – the IRS regulations state “buy, build or rebuild.” You can also use the money for costs related to the purchase, like closing costs. There’s a $10,000 lifetime limit on waiving the penalty on earnings for this exemption. 

College Expenses

Qualified education expenses also avoid the penalty, and can be for you, a spouse, or your children. The range here is pretty broad - qualified higher education expenses include tuition, fees, books, supplies, and equipment required for enrollment. Room and board are also covered for students who are enrolled at least half-time.

Birth or Adoption

If you’ve just had a baby or adopted, you can withdraw up to $5,000 from a Roth IRA, without the 10% penalty. Each parent can use the $5,000 exemption for a total of $10,000 penalty-free. 

Substantially Equal Periodic Payments

If you have a substantial balance in your Roth IRA and you want to begin taking withdrawals before age 59 ½, the IRS allows you to avoid the penalty by taking a series of substantially equal periodic payments over your life expectancy. The IRS provides several ways to determine the amounts of the payments. You need to be careful because making changes can subject you to the 10% penalty unless done correctly. 

Permanent Disability

If you become permanently disabled, the IRS waives the 10% penalty for early withdrawals before age 59 ½. 


The Bottom Line

Because Roth IRAs allow money to grow tax-free and withdrawals that meet the five-year rule and the age requirement are tax-free, they are an extremely valuable retirement asset. They can provide maximum income flexibility and potentially help keep your taxable income low in retirement – which means you may lower taxes on social security or avoid the Medicare Part B and Part D surcharge. 

But there are times when it makes the a lot of sense to withdraw from your Roth IRA. Keep in mind that even if you can avoid the penalty, you may still have to pay taxes on earnings. Before you decide to withdraw from a Roth, even if you qualify for an exception to the 10% penalty, take a careful look at your entire financial situation and weigh other options. Keep in mind, the true value of a Roth IRA is the tax-free growth potential over years of investing. In order to take advantage of this, the money needs to stay in there! However, life is full of challenges and one of the things we love about Roth IRA accounts is that they have lots of flexibility and can be used to help meet these challenges if they arise.

If you have any questions about your Roth IRA account or ways you might consider taking advantage of this vehicle, feel free to schedule some time to discuss!