You probably know that using a Roth IRA to save for retirement is a smart move that also cuts your taxes. But what you may not know is that unlike other types of retirement accounts, you can spend it before retirement. Laura explains the unique flexibility of a Roth IRA and covers 4 ways you’re allowed to make penalty-free withdrawals from a Roth IRA to spend anytime you like.
How Your Age Affects Roth IRA Withdrawals
Age is a critical factor when it comes to retirement accounts because they’re designed to encourage you to invest for the long-term. Just about all of them set 59½ as the official retirement age when you’re allowed to begin taking withdrawals. Before that age, taking an early withdrawal comes with a 10% penalty that you must pay in addition to regular income tax.
If you’re over age 59½, you won’t be subject to an early withdrawal penalty for the earnings portion of a Roth IRA; however, if you haven’t owned the account for 5 years, you would have to pay income tax on them. As I previously mentioned, the 5-year rule applies no matter your age.
If you’re under age 59½ and withdraw earnings from a Roth IRA, they will be subject to the 10% early withdrawal penalty—unless you qualify for an exemption, which I cover in a moment. And if you didn’t own the account for 5 years, income tax would also apply.
For example, if you opened a Roth IRA in 2010 and have contributions that total $10,000 and earnings of $1,000, your account is now worth $11,000. If you turned 59½ in 2017, you meet the 5-year holding rule and the age requirement that allows you to make withdrawals of both contributions and earnings with no taxes or penalties.
But let’s say you have the same account, are 40 years old, and want to withdraw the full $11,000, which includes $1,000 of earnings. In that case, you’d have to pay income tax on $1,000. In addition, you’d be subject to the extra 10% early withdrawal penalty—unless you qualify for an exemption.
4 Penalty-Free Ways to Use a Roth IRA Before Retirement
Assuming you satisfy the 5-year rule, here are 4 ways you can spend Roth IRA earnings penalty-free (but not tax free) before retirement:
1. Higher education expenses.
If you plan to pay for college, that’s one of the best reasons to have a Roth IRA. The tax-free growth is like what you get with a 529 plan, which is a dedicated college savings account.
If you plan to pay for college, that’s one of the best reasons to have a Roth IRA.
However, depending on the 529 plan you choose, the tax benefits could be even better than a Roth IRA because some states offer residents additional incentives. So be sure to do your homework and compare options when paying for college is one of your financial goals.
But unlike a 529 plan, if you don’t end up needing some or all the money for college, you can simply leave it in a Roth IRA and use it for another reason or for retirement.
The education penalty exemption is allowed no matter if you plan to pay expenses for yourself, your spouse, or either of your grandchildren. Allowable, qualified expenses include tuition, fees, books, supplies, and equipment (including computers) required to attend an eligible institution. Plus, if the student attends school at least half-time, room and board qualifies as well.
The funds can be used at just about all accredited private or public schools—such as colleges, universities, and vocational schools—that participate in student aid programs administered by the U.S. Department of Education. If you’re not sure whether a school qualifies, the registrar should know.
2. Buying a first home.
If you plan to buy, build, or rebuild a first home, you can spend up to $10,000 penalty-free from a Roth IRA. Or a couple who each has a Roth could withdraw a total of $20,000. This is a lifetime limit, so you can only claim this exemption once.
The IRS definition of first-timer homeowner is very broad. Even if you’ve owned a home before, you’re considered a first-timer if neither you nor your spouse have owned a primary residence within the last 2 years. However, if you’re married, your spouse must also be considered a first-timer.
Even if you’ve owned a home before, you’re considered a first-timer if neither you nor your spouse have owned a primary residence within the last 2 years.
You can use this exemption to pay costs associated with buying a primary home for yourself, your spouse, either of your children, either of your grandchildren, or either of your parents or grandparents.
As always, your contributions to a Roth IRA are available to you at any time for any purpose. So, if you have the savings set aside, you could tap that portion of your account for a larger down payment that’s both tax and penalty free.