You can usually consider a Roth IRA to be tax-free, but there are times when you may have to pay taxes.
What is a Roth IRA?
A Roth IRA is a post-tax retirement plan. When you contribute, you contribute after-tax dollars and don’t get a tax deduction. In return, you don’t have to pay taxes on your withdrawals in retirement.
How do Roth IRA tax-free withdrawals work?
There are several times you can withdraw money from a Roth IRA tax-free.
As a general rule, you can withdraw the money you contributed to a Roth IRA at any time. It doesn’t count as taxable income, and there’s no penalty.
The reason is that you didn’t get a tax benefit on your contributions. The early withdrawal penalty on Traditional IRA contributions accounts for the fact that you got a break on your income taxes that you now have to pay back.
For example, if you’ve contributed $10,000 to your Roth IRA and it has grown to $15,000, you can withdraw up to $10,000. Taxes and penalties would usually only kick in if you touched the $5,000 in growth.
A common move is for people to use a Roth IRA as their emergency fund if they can’t both max their IRA and set up a separate emergency fund. This allows you to hopefully grow your retirement savings while still having money available if you need it.
Once you hit age 59.5, you can generally withdraw all of the money in your Roth IRA without paying any taxes. This includes both contributions and growth.
In order to withdraw growth without taxes or penalties, your Roth IRA generally needs to have been open for at least five years. This includes if you moved funds to a new Roth IRA account recently but the account you moved the funds from was opened more than five years ago.
If you converted a traditional IRA or 401(k) to a Roth IRA, there is also usually a five-year waiting period before you can withdraw those funds without taxes or penalties.
Home Buying Exception
There is also a special rule for tax-free IRA withdrawals if you’re a first-time homebuyer.
If you’ve had your Roth IRA for at least 5 years, you can typically withdraw $10,000 in earnings without taxes or penalties if you use the money to buy or build your home.
This $10,000 comes after any contributions that you withdraw. So the tax-free amount you can withdraw from your Roth IRA as a first-time homebuyer is actually your total contributions plus $10,000.
There are also certain qualified distributions that you can take before age 59.5 that are subject to income taxes but not penalties. These include:
- Qualified education expenses
- Medical expenses exceeding 7.5% of your AGI
- Expenses related to the birth or adoption of a child
- Paying an IRS levy
- Taking substantially equal distributions
- Certain withdrawals by military reservists called to active duty
Remember that you can still withdraw contributions without taxes or penalties at any time. These rules generally only kick in after you’ve withdrawn your contributions.