Roth Ira

So, you have been saving like an ant for that luxurious retirement. You diligently put the maximum amount of you can into your Roth IRA. Suddenly something horrible happens. Your car suffers a catastrophic failure. You need to fix the foundation to your house. You want to by your very first house. But maybe it is not so catastrophic after all. For whatever you need the money, you're thinking you can take an early withdrawal from your Roth IRA. Let's talk about that.

First we will discuss the IRS's crazy ordering scheme for withdrawals from one of multiple Roth IRA accounts. The IRS, in all its glory, has mandated that distributions from Roth IRA accounts must occur in this order. First withdraw from non-taxable annual contributions to a Roth IRA; second, from conversion contributions, on a first-in first-out basis; and lastly from Roth IRA earnings.

Now, we are going to talk about the most common occurrence…an early withdrawal from your Roth IRA without any qualified exceptions. For this case, you will face a 10% early withdrawal penalty. That is right. Just for taking an early withdrawal from your Roth IRA, you will have 10% of your money take away. This is in ADDITION TO the income tax that will be accessed on the earnings of your Roth IRA.

Here is an example. Mike is 40 years old. He currently has a Roth IRA account with a balance of $8,000. This balance consists of $5,000 in contributions and $3,000 in earnings. For no reason at all, just to get at his money, Mike decides to close his Roth IRA and take the balance as a non-qualified distribution. Because the distribution is not qualified, Mike will owe income taxes on his earnings.

Let's calculate. Mike will be taxed at his usual tax bracket of 28%. 28% of $3,000 is $840. So right off the bat, he's lost $840 of his hard earned money. But wait, because this is a non-qualified distribution, he will also get hit with a 10% early withdrawal fee…that's another $300. So just for an early withdrawal from his Roth IRA Mike will be spending $1,140. Of the $8,000 in his account, Mike will only take home $6,860. What a price!

However, if Mike were to fall into certain early withdrawal exceptions, he might be able to get his money back penalty free. Let's see what Mike would have to do get away penalty free.

One of the worst situations is that Mike would have to become totally and permanently disabled. The IRS has a very strict definition of disabled so Mike will need to determine if he is disabled according to the IRS.

The worst situation is that Mike dies. Then the distribution to his beneficiary will be distributed without penalty.

Again, something Mike doesn't want to happen, but if Mike has a substantial amount of medical bills, then IRS will allow him to take an early withdrawal from his Roth IRA in order to pay those. At least the IRS understands that Mike is in a hard position.

If Mike is purchasing his first home, the IRS will allow him to take an early withdrawal for that too. The IRS obviously values home ownership.

Mike can also get an education penalty free.

And lastly, he can take a penalty free early withdrawal from his Roth IRA penalty free…if he owes the IRS back taxes. Of course the IRS will allow him to take an early withdrawal penalty free…all the money is coming to them anyway.