Early withdrawal penalties for Roth IRAs

You may be tempted to withdraw money early from your retirement accounts, but proceed with caution.

Many may be tempted to do this with Roth IRAs, in particular, because contributions are made after you pay taxes. They also come with more flexible withdrawal rules than traditional IRAs. But there are always penalties and pitfalls to consider.

Roth IRA withdrawal rules and penalties

You can withdraw your original Roth IRA contributions for any reason and at any time without penalty or tax. However, your earnings from those contributions may be subject to income tax or penalties in certain situations. (You must reach the retirement age of 59 ½ and the account needs to have been open for at least five years before withdrawing your earnings on those contributions without penalty.)

Learn more about Roth IRAs or consider opening an account today to launch your retirement savings.

Regular contributions and qualified distributions aren't taxable. Roth IRA distributions that return your regular contributions (also called withdrawals) are tax-free and aren't subject to the 10% penalty. 

There are three types of Roth IRA distributions or withdrawals:

1. Return of regular contributions (or withdrawal of contributions)
2. Qualified distributions, also known as a qualified withdrawal
3. Non-qualified distributions

You can avoid the 10% penalty in some situations when withdrawing funds (also called a distribution) from your Roth IRA. It's a good idea to check with a financial adviser or the Internal Revenue Service (IRS) before making a move.

Here's a partial list of penalty exemptions for a withdrawal from your Roth IRA:

• Retirement age of 59 ½ or older
• Totally and permanently disabled
• Using the funds to buy, build or rebuild a first home (up to $10,000 over a lifetime)
• Using the funds for unreimbursed medical expenses or health insurance that are more than 7.5% of your adjusted gross income (AGI)
• Paying health insurance premiums while unemployed
• Under a levy from the IRS for the IRA or retirement plan
• Withdrawing funds that aren't more than a qualified higher education expense

What is a qualified distribution?

A qualified distribution, or withdrawal, must meet certain conditions to avoid income tax or a 10% penalty.

Qualified distributions must both be made:

• After a five-year period that is counted from the first taxable year for which a Roth IRA contribution was made
• After the age of 59½
• Because of disability
• To a beneficiary or estate after death
• To purchase, build, or rebuild a first home up to a $ 10,000 lifetime limit, according to the Internal Revenue Service.

Withdrawing from an inherited Roth IRA

When a Roth IRA owner dies, some minimum distribution rules that apply to traditional IRAs also apply to inherited Roth IRA beneficiaries. Be sure to thoroughly research the details or consult a financial adviser.

Distributions, or withdrawals, from inherited Roth IRAs are generally tax-free. But if your Roth IRA was opened fewer than five years before you inherited it, you may owe taxes. You may also owe taxes if the inherited Roth IRA was converted from a traditional IRA fewer than five years before the converted Roth IRA owner dies. The IRS treats this as a "nonqualified distribution."

If you're interested in opening up a new Roth IRA, make sure you spend some time researching the options available to you.

Reasons to withdraw early from your Roth IRA

Taking an early distribution can actually be a good decision in some situations. You might consider an early withdrawal if:

• You're buying or building a house for the first time
• Unreimbursed medical expenses need to be paid
• You're over 59 ½ and need to tap a source of cash
• You have a higher education expense that qualifies

Of course, working with your financial advisor will help you better understand these scenarios and how an early withdrawal can affect your retirement plan.

Can you borrow against a Roth IRA?

"The short answer is no, you cannot borrow or loan yourself money from your Roth IRA," says Kaleb Paddock, a certified financial planner with Denver-based Ten Talents. There is a potential "workaround" if you withdraw funds from your Roth IRA and put them back via a deposit within 60 days, Paddock notes. That way, you avoid taxes and penalties.

"Just remember to code this correctly when you file your taxes the following year since you will receive a Form 1099 as a result of the withdrawal," Paddock says. But be careful. If you wait until day 61 or later, your withdrawal is subject to penalties and possible taxes if you haven't met the "5-year rule" and have investment gains in the Roth IRA, Paddock notes. Exceptions may apply. It's best to seek advice first.

Other investment vehicles

If the penalties for withdrawing from a Roth IRA seem unattractive then there are other investment vehicles to consider that have different and, depending on your personal financial situation, potentially more advantageous parameters.

• 401(k): A 401(k) is arguably the most convenient way to save and invest. This allows employees to have a pre-determined percentage of their income put to the side and invested in an account. The money is deducted from the check prior to taxes. The amount you contribute is specific to your goals and preferences although higher amounts are usually better if they can be afforded.
• Gold IRA: Gold IRAs offer nontraditional financial protection and are typically used as a hedge against inflation, so the benefit of using one is particularly timely. Learn more about how to buy gold now.
• Rental properties: While not recommended as a primary source for retirement investing, rental properties also offer unique financial benefits, should you choose to pursue that option.