Things to Know If You Are Planning an Early Withdrawal from Your Roth IRA

Are you thinking about cashing in on your Roth Individual Retirement Account (IRA) early? Before you make the move, it is important to understand what you are really signing up for and how this one decision affects multiple things.

First off, let’s clear up some confusion. There are several types of IRAs, such as Traditional, Roth, Simplified Employee Pension (SEP), and Savings Incentive Match Plan for Employees (SIMPLE). However, when it comes to taxes, the two main ones you need to know about are Traditional and Roth. The rules around withdrawals and tax treatment are very different for each. With a Traditional IRA, you are expected to start taking Required Minimum Distributions (RMDs) once you turn 73, as of 2025. These withdrawals are taxed as regular income. But withdrawals from a Roth IRA are not taxed, as it is funded with money you have already paid taxes on. There are also no RMDs.

Sounds great, right? But if you are planning to take money out from a Roth IRA before you turn 59½, there would still be some cuts. While Roth IRAs are more flexible than Traditional IRAs, there are rules you need to follow to avoid taxes and penalties.

This article will help you understand the rules around a Roth IRA early withdrawal and walk you through what to consider before tapping into your retirement savings early. Stay tuned!

What is an early withdrawal from a Roth IRA?

If you are thinking about pulling some of your Roth IRA money out early, it is essential first to understand how early withdrawals work.

The good news is that Roth IRAs are quite tax-friendly when it comes to withdrawals. So, the money you put into your Roth IRA, which is your contributions, is always yours to take out. You do not have to pay any tax, nor do you need to worry about a penalty. You can withdraw these anytime and for any reason.

Here’s an example that can help you understand this better:

Let’s say you contributed $10,000 to an IRA over the last couple of years, and your account has grown to $12,500. Now, you have a financial emergency which requires instant cash. You can take out your original $10,000 whenever you want, without paying a single penny in taxes or penalties. But the earnings, in this case, the extra $2,500 your money has made through investments, are a different story. Those will attract some deductions unless some conditions are met. What are these? Let’s find out.

To withdraw your earnings tax-free, the following things have to be true:

• Your Roth IRA must be at least five years old
• You must be at least 59½
• The withdrawal must qualify under one of the Internal Revenue Service’s (IRS) rules for a qualified distribution (The article will cover these in another section below)

If you have not met any of those conditions, any earnings you withdraw may be subject to income taxes and a 10% early withdrawal penalty.

Now, let’s talk about Roth conversions.

If you have converted money from a Traditional IRA to a Roth IRA, those converted amounts can also be withdrawn tax and penalty-free, but only after they have aged five years in the Roth and provided you are 59½. And a major catch here that a lot of people tend to miss is that each conversion has its own five-year clock. So, if you converted funds in 2022 and then again in 2023, the 2022 money becomes penalty-free in 2027, while the 2023 amount has to wait until 2028.

If you have had your Roth IRA for more than five years and you are over age 59½, you are generally in the clear. You can withdraw both your contributions and your earnings with no taxes and no penalties. But since these things can be pretty confusing, talking to a financial advisor can be helpful to get some clarity. Advisors can help you understand how to withdraw from a Roth IRA early, while adhering to the prevailing rules.

Qualified and unqualified withdrawals

When it comes to taking money out of your Roth IRA, you will hear two terms a lot – qualified and non-qualified withdrawals. Let’s start with the basics and break it down.

Whether your withdrawal is qualified or not decides whether you owe taxes or penalties on a premature Roth IRA distribution.

So, what is a qualified withdrawal?

A qualified withdrawal refers to money you can take out of your Roth IRA completely tax-free and penalty-free. Qualified withdrawals require you to meet some conditions. The main thing to remember is that your Roth IRA must be at least five years old and you should be at least 59½ years old. Additionally, you must be withdrawing under one of the following circumstances:

• You have become permanently disabled
• You have experienced domestic abuse
• You are using the funds for qualified education expenses
• You are using the money for a first-time home purchase. This has a lifetime limit of up to $10,000
• You are paying for unreimbursed medical bills or health insurance premiums while being unemployed
• You are covering the costs of birth or adoption. This has a limit of up to $5,000 per parent
• There is an IRS levy on your account
• The distribution is due to a federally declared disaster
• You are taking substantially equal periodic payments as part of a long-term withdrawal plan
• You have passed away, and your heirs are taking the money out

If these conditions are met, you are free to take out your contributions, conversions, and earnings, all tax and penalty-free.

Moving on to what is a non-qualified withdrawal. If you do not meet the requirements mentioned above, your Roth IRA early withdrawal is considered non-qualified. However, that does not automatically result in a tax or penalty on everything. It depends on what part of your account you are withdrawing from.

Withdrawals from a Roth IRA happen in this order:

• Contributions: These are always tax and penalty-free. So, you can access your money anytime you want.
• Conversions: These are taxed when you first move funds from a Traditional IRA to a Roth one. But if you take them out before they have been in your Roth IRA for five years, you may face a 10% penalty even if you’re over 59½.
• Earnings: If you withdraw earnings early and do not meet any exception listed above, you will owe income tax plus a 10% penalty on your withdrawal.

Consequences of a premature Roth IRA distribution

Now that you know the rules about early withdrawals, taxes, and penalties, it is time to move on to what happens next. Let’s say you decide to make a premature withdrawal. It is important to understand the trade-offs of this decision, first. Here are some consequences of an early withdrawal from a Roth IRA:

1. Your long-term investment growth is compromised

Even if you only take out your contributions, which you can do tax and penalty-free, your Roth IRA is left with less money. And less money means less power to grow through compounding.

For instance, if you have contributed $10,000 and your account grows to $12,500 over a couple of years, you gain compounding benefits on the full $12,500. However, if you withdraw the original $10,000, you will be left with just $2,500 in the account. This small amount will still grow, sure, but not at the same pace or scale as before.

The more you let your investments sit and grow, the more you benefit from compounding. When you take money out early, you break the process. And over time, this affects how much you have for retirement.

2. Your investment horizon is shortened

Roth IRAs are designed for long-term goals, such as retirement. Historically, long-term investing has proven to outperform short-term market moves. When you stay invested for a longer time without interrupting your investments, you give your money a chance to ride out the ups and downs and grow. Withdrawing early can come in the way of this opportunity.

3. Your financial progress takes a hit from debt

Let’s talk about one of the tougher decisions – the debt factor. You might find yourself stuck between two difficult choices: to tap into your retirement savings now to avoid debt or leave your IRA alone and take on a loan instead. Both options have consequences. And neither one is automatically right nor wrong. Let’s discuss both scenarios:

• Scenario 1: You do not withdraw, and you take on debt

Say you have an urgent expense, such as a home repair, but you decide not to touch your Roth IRA. That may protect your retirement savings, but it could also push you into borrowing money to cover your needs. Now you may be dealing with monthly debt obligations and recurring essentials. The money you are using to repay that debt could be money you would otherwise be putting into your IRA.

In other words, the debt could slow down your retirement contributions, which may potentially hurt your long-term financial growth just as much as an early withdrawal would.

• Scenario 2: You withdraw now and risk debt later

On the flip side, if you take money out of your Roth IRA now, you may find temporary relief. But you will also be left with less saved for your future. If you retire with a smaller pool of savings, you may end up relying on loans or credit cards in retirement. This is the very thing you were trying to avoid in the first place.

So, what is worse?

You need to take a look at your current needs, age, present savings, and consider your future goals. If you are young, you may be able to make up for it eventually. However, if you are closer to retirement, be aware of the possibility of not being able to make up for lost time.

This is one of those moments where speaking with a financial advisor can be incredibly helpful. They can walk you through the pros and cons and make a decision that is more personalized to your situation.

Alternatives to a Roth IRA early withdrawal

1. Build an emergency fund

An emergency fund is meant for situations just like this. If you already have one, now is the time to use it. That is precisely what it is there for. But if you do not have one yet, it is a sign to start building one as soon as you are back on your feet. An emergency fund creates a financial safety net that keeps your retirement savings untouched in future emergencies.

2. Consider liquidating other investments first

If you are facing a financial crunch and do not have an emergency fund, look at your other investment options before turning to your Roth IRA. Do you have mutual funds, stocks, etc., that can be liquidated without major penalties or tax consequences? Compare all the choices to see which one would have the least long-term impact on your financial future. Pulling from a Roth IRA might not be your best move if you have other resources available.

Bottom line?

Yes, a Roth IRA gives you the flexibility to withdraw funds early. And when you have that option, you may want to use it. However, you must know how this one decision can impact your present and future. The consequences of a premature Roth IRA distribution go far beyond just taxes and penalties. You could be compromising your future financial security, limiting the growth of your retirement fund, and creating more stress for yourself. Once that money is out, rebuilding your account can take years, and by then, you would have missed out on compounding. There is also the peace-of-mind factor. Emptying your Roth IRA too soon could impact you emotionally, too.

So before making any decisions, consider the impact both now and later. Look at other alternatives. And most importantly, talk to a professional. Not sure where to start? Use Wiser Advisor’s free advisor match tool to match with trusted advisors who can answer any queries you may have on making early withdrawals from a Roth IRA.

For additional information on retirement planning strategies that can be tailored to your specific financial needs and goals, visit Dash Investments or email me directly at dash@dashinvestments.com.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.