Traditional & Roth IRAs: Withdrawal Rules and Early Withdrawal Penalties

Trying to determine which IRA is best for you – traditional or Roth? It’s important to understand the traditional IRA and Roth IRA withdrawal rules and early withdrawal penalties as they are very different. Read on and we’ll outline everything you need to know about the when and how for taking money out of a traditional and Roth IRAs.

Roth IRA Withdrawal Rules

Because your Roth IRA contributions are made with after-tax dollars, you can withdraw your regular contributions (not the earnings) at any time and at any age with no penalty or tax. After you withdraw an amount equal to all of your regular contributions, the earnings will be taxable only if the distribution isn’t a qualified distribution. If the distribution is qualified, then none of your distribution will be taxed.

All of your Roth IRAs are treated as one for the purposes of withdrawal rules. It doesn’t matter how many Roth IRA accounts you have.

Roth IRA Early Withdrawal Penalty & Converted Amounts

If you convert a traditional IRA to a Roth IRA, you must pay taxes on the conversion, but then you never have to worry about paying taxes again on that IRA for qualified withdrawals, even if future tax rates are higher. However, the Roth IRA withdrawal rules differ for Roth conversions. To take a tax-free distribution, the money must stay in the Roth IRA for five years after the year you make the conversion.

If you withdraw contributions before the five-year period is over, you might have to pay a 10% Roth IRA early withdrawal penalty. This is a penalty on the entire distribution. You usually pay the 10% penalty on the amount you converted. A separate five-year period applies to each conversion.

If you’re at least age 59 1/2 when you make the withdrawal, you won’t pay the 10% early withdrawal penalty. This applies no matter how long the money is in the account. You also won’t pay a penalty if you:

  • Use the distribution for a first-time home purchase — up to a $10,000 lifetime limit
  • Qualify for other exceptions that apply to traditional IRAs

Distribution Ordering Rules for Roth IRAs

If the money you withdraw from a Roth IRA isn’t a qualified distribution, part of it might be taxable. Your money comes out of a Roth IRA in this order:

  1. Regular contributions — always tax- and penalty-free
  2. Conversion contributions — which come out on a first-in, first-out basis. So conversions from the earliest year come out first.
  3. Earnings on contributions

Roth IRA Earnings & Withdrawal Rules

Your earnings are tax-free if both of these are true:

  • You’ve had the Roth IRA for at least five years.
  • You’re age 59 1/2 or older when you withdraw the money.

The Roth IRA earnings you withdraw are tax-free at any age if both of these rules apply:

  • You’ve had the Roth IRA for at least five years.
  • You qualify for one of these exceptions:
    • You used the money for a first-time home purchase — up to the $10,000 lifetime limit.
    • You are totally and permanently disabled.
    • Your heirs received the money distributed after your death.

If you die before meeting the five-year test, the IRS will tax your beneficiaries on distributed earnings until this test is met.

No matter your age, your earnings are taxable if you don’t meet the five-year test. This is true even if your earnings are penalty-free.

Each traditional IRA you convert to a Roth IRA has its own five-year holding period to avoid an early withdrawal penalty. The IRS requires your IRA custodian or trustee to send you Form 5498. This shows your:

  • Annual IRA contributions
  • All IRA conversions

You should receive the form by the end of May. Keep these records even though you don’t report your Roth contributions on your return.

When you withdraw money from your Roth IRA, you must report it on Form 8606, Nondeductible IRAs. This form helps you track your basis in regular Roth contributions and conversions. It also shows if you’ve withdrawn earnings. If you’ve held your Roth IRA for at least five years and you’re older than age 59 1/2, all withdrawals will be tax-free.

Required Minimum Distributions for Roth IRAs

There’s no required minimum distribution for a Roth IRA prior to the account owner’s death. So, you’re not required to withdraw any money during your lifetime. This is an advantage over a traditional IRA.

If you’ve held your Roth IRA for at least five years and you’re older than age 59 1/2, money you withdraw will be tax-free. If you open a Roth IRA account after you turn 59 1/2, you still have to wait at least five years before you can take distributions of your earnings without an early withdrawal penalty. However, you can take tax-free withdrawals of your contributions at any time.

Traditional IRA Withdrawal Rules

Traditional IRA Distributions

If you wait until you’re older than age 59 1/2, you won’t pay the 10% early withdrawal penalty on your IRA. If you deducted your traditional IRA contributions, the money you withdraw is taxable. However, if you made nondeductible contributions, part of your withdrawal will be tax-free.

Required Minimum Distributions

As a rule, you must begin withdrawing money from your traditional IRA when you reach age 70 ½. Your first withdrawal must be made by April 1 after the year after you reach 70 ½ and subsequent withdrawals must be taken by December 31 each year. If you don’t withdraw the minimum amount, you may have to pay a penalty equal to 50% of the amount you should have withdrawn.

If your 70th birthday is between January and June, you’ll turn age 70 ½ before the end of that year; if your birthday is after June 30 you’ll turn 70 ½ the following year. Although the Traditional IRA withdrawal rules allow you to delay your first required minimum distribution from your IRA to April 1 of the next year, you might want to take your first distribution in the year you turn age 70 ½. By doing this, you avoid having to take two distributions in the next calendar year.

Minimum IRA withdrawal rules are based on life expectancy. The RMD for the current tax year is the total of your IRA account balances at the end of the previous tax year divided by your life expectancy, which is based on your age and the tables shown in Appendix B in IRS Publication 590-B. Then, you can take the full RMD amount from any one or several IRA accounts. As explained above, if you fail to withdraw the minimum required amount, you’ll be subject to the 50% penalty. However, if you have reasonable cause for not withdrawing the minimum amount, the IRS might waive the penalty.

Important: RMDs also apply to qualified plans such as 401(k)s. However, some qualified plans allow actively working employees who are over 70½ to delay taking minimum required distributions from that plan until they retire from that company. Any such delay applies only to that company’s plan, so if this applies to you, check with the plan administrator as to whether you must take an RMD from the qualified plan. Regardless, you must begin taking your traditional IRA withdrawals when you turn 70 ½ as well as from other retirement plans even if you’re still working.

Early Withdrawal Penalties for Traditional IRAs

You can receive distributions from your traditional IRA before age 59 1/2 without paying the 10% early withdrawal penalty. To do so, one of these conditions must apply:

  • You have unreimbursed medical expenses that are more than 7.5% of your 2018 AGI (This threshold will rise to 10% for the 2019 tax year).
  • The distributions aren’t more than the cost of your medical insurance due to a period of unemployment.
  • You’re totally and permanently disabled.
  • You’re the beneficiary of a deceased IRA owner.
  • The distributions aren’t more than your qualified higher education expenses.
  • You use the distributions to buy, build, or rebuild a first home.
  • The distribution is due to an IRS levy of the qualified plan.
  • The distribution is a qualified reservist distribution.
  • You’re receiving distributions in the form of an annuity, in which case these conditions must apply:
    • The distributions must be part of a series of substantially equal periodic payments over your life. They could also be over the joint lives of you and your beneficiary.
      You’ll need to use a distribution method the IRS approves, and you must take at least one distribution annually.
    • You must continue making these withdrawals for at least five years and until you’re at least age 59 1/2. 

Traditional IRA Withdrawal Rules After Death

If a person dies while there’s still money in their traditional IRA account, the beneficiaries:

  • Won’t pay the 10% early withdrawal penalty — the deceased’s age or the beneficiaries’ ages don’t matter.
  • Will pay taxes on distributions the deceased took if the deceased would have paid taxes on the distributions. It doesn’t matter that the funds are inherited.

If the deceased had a basis in the IRA, the beneficiaries inherit this basis. They must use Form 8606 to figure the taxable portion of the distributions.

If you inherit an IRA from your spouse, you can treat the IRA as your own. Then, you can put off taking the required minimum distribution until you reach age 70 1/2. If you’re not a spouse, you must figure your required minimum distributions from the account. To do this, you must use the IRS life expectancy table for beneficiaries.

Roth IRA Withdrawal Rules After Death

Roth IRAs have different withdrawal rules if they are inherited. If you inherit a Roth IRA, you can withdraw the money tax-free. However, the IRA must first meet the five-year period to avoid a Roth IRA early withdrawal penalty.

If you inherit the Roth from your spouse, you can treat it as your own. You won’t need to make required withdrawals during your lifetime.

However, if you’re not the deceased’s spouse, you must either:

  • Withdraw everything from the Roth IRA by the end of the fifth year after the owner died.
  • Begin withdrawals by Dec. 31 of the year the beneficiary must take the first required distribution using his or her life expectancy. Or, begin withdrawals Dec. 31 of the year containing the fifth anniversary of the owner’s death, if earlier. The amount you must withdraw is based on your (the beneficiary’s) life expectancy. 

Early Withdrawal Penalty and Deductions

If you’re wondering if you can claim a deduction on an early withdrawal penalty, the answer is no. The 10% early withdrawal penalty isn’t deductible.

Looking for Help Understanding Traditional or Roth IRA Withdrawal Rules?

There’s a lot to take in where traditional and Roth IRA withdrawal rules are concerned. If you need help understanding your options, our knowledgeable tax pros can help.

Make an Appointment to speak with one of our tax pros today.

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