Thinking about taking a withdrawal from your Roth IRA and assuming it’s tax-free? Before you do, check your calendar and time it right.
Withdrawals from Roth accounts are exempt from federal income tax if you are 59-½ or older and have had at least one Roth open for over five years.
The above qualifications must be in place for you to withdraw without tax penalties.
Fun Fact: The five-year ownership period begins on January 1 of the first tax year for which you make the Roth contribution. For example, if you make a contribution on April 1, 2022, for the 2021 tax year, your five-year period starts on January 1, 2021. Anytime after January 1, 2026, you can take qualified, tax-free withdrawals assuming you are 59-½ or older on the withdrawal date.
The first Roth sets the five-year plan, and the others fall in line with it. During the five-year period, you can open up additional Roth accounts which will fall under the exact same date guidelines as the initial Roth. Even if they are opened in a different calendar year.
The key is to make sure your withdrawal is actually qualified before pulling the trigger! Play by the rules and get your timing right, and you’ll avoid taxation on Roth withdrawals.
Knowing the rules is critical if you must take a non-qualified Roth IRA withdrawal. A non-qualified withdrawal is potentially subject to federal income tax. In addition, non-qualified withdrawals taken before age 59-½ may be subject to a 10 percent early withdrawal tax.
Non-qualified withdrawals are defined by the following:
- Taken before age 59-½
- Taken before you’ve passed the five-year period
There is one big exception to this rule for first-time homebuyers.
First-Time Home Purchase Exception
Assuming you’ve passed the five-year period, this exception allows tax-free and penalty-free Roth withdrawals when spending the money within 120 days on a qualified principal residence acquisition. This is available to taxpayers under the age of 59-½ who have passed the five-year test. However, there is a $10,000 limit, and the buyer must not have owned a present interest in a principal residence within the two-year period that ends on the acquisition date.
If you are taking a Roth withdrawal, be sure you properly complete Part III of IRS Form 8606 and enter the correct amount (which might be zero) on line 4b of your Form 1040. If your withdrawal is non-qualified, be ready for the 10 percent early withdrawal penalty tax, which you must calculate on IRS Form 5329 when it applies.
If you plan to take one or more big non-qualified Roth IRA withdrawals during the year, speak with me to advise you on both the front and back ends of your withdrawal.