Every Roth IRA account owner knows that the main benefit of the Roth IRA is that there are no taxes due on withdrawals taken after the account owner is 59 ½. However, what taxes or penalties apply to distributions taken before the Roth IRA owner reaches 59 ½?
Roth IRA distributions before age 59 ½ are broken into two categories, contributions and earnings.
Contributions Can Be Withdrawn Before 59 ½ Without Tax or Penalty
The first first category is Roth IRA contributions. This category is distinct because these amounts have been subject to tax before the funds were included in the Roth IRA. The amounts withdrawn from a Roth IRA that do not exceed the amounts of Roth IRA contributions are not subject to taxes or penalties upon early distribution from the Roth IRA. However, any amounts distributed in excess of the Roth IRA contributions, which would typically be the investment returns, are subject to taxes and the early withdrawal penalty of 10%.
This is an excellent perk as it allows Roth IRA owners to take money back that they contributed to the Roth IRA without worrying about penalties or taxes.
Earnings Are Subject to Tax the 10% Early Withdrawal Penalty
Amounts withdrawn before 59 ½ that comprise the Roth IRA’s earnings are subject to tax and a 10% early withdrawal penalty. IRC § 408A(d)(2)(A) & Treasury Reg. §1.408A-6, Q&A-1(b). “Earnings” is the amount over the sums you have contributed to the Roth IRA, and is essentially your investment returns and gains.
Since there are taxes AND penalties on the earnings, you should only take distributions when absolutely necessary.
Example of Roth IRA Distribution Before 59 ½
For example, let’s say a Roth IRA owner is 45 and has a Roth IRA with $65,000. This balance consists of $35,000 in Roth IRA contributions and $30,000 in earnings or investment returns. If the Roth IRA owner took a distribution of the entire account then $35,000 would NOT be subject to early withdrawal penalties as this amount comprised Roth IRA contributions where taxes have been paid already. However, the remaining $30,000 distributed represents investment returns/gains made in the Roth IRA and would be subject to early withdrawal penalties of 10% and must be also be included in the taxable income of the Roth IRA owner. As a result, Roth IRA owners under age 59 ½ should avoid distributions of their Roth IRA in excess of their contributions.