Warning: Creating default object from empty value in /home4/mldbm01/public_html/wp-content/themes/optimize/optimize/functions/admin-hooks.php on line 160

Many people get confused on the rules and penalties on withdrawing or distributing money from their Roth IRA. First, these rules are the same if it is a self directed account or not. Second, if you are over the age of 59½, then only the 5 year rule applies for tax and penalty. What is the 5 year rule? The 5 year rules states that any earnings distribution prior to the first day of the fifth year after your first Roth was established will be taxed as ordinary income, at whatever your tax rate is at the time. For example, you open a Roth IRA on April 8, 2009. The 5-Year Rule will be satisfied as of January 1, 2014.

One of the unique benefits of a Roth IRA is that you can pull out some of your funds anytime at any age without any penalty or tax for any reason whatsoever. Only certain funds are allowed this luxury. For example, you can withdraw the amounts that you’ve contributed to the account through regular annual contributions. You can withdraw up to the amount of your contributions with no penalty or tax as long as your withdrawal isn’t greater than the amount of your overall contributions. The withdrawal doesn’t have to be for any specified purpose. Also included in this category are conversion amounts that were converted more than five years prior.

Any distributions of converted amounts (assuming they were taxable at the date of the conversion) will be subject to the 10% penalty (though they’ll be free from ordinary income taxes) if the distribution occurs prior to the first day of the fifth year after the date of the conversion. If, however, the distribution was for a qualifying reasons (shown below)the distribution will be free from penalty. If the conversion included amounts that were not taxable (because they came from a nondeductible IRA), those amounts will not be subject to the 10% penalty even if they are withdrawn from the Roth prior to the first day of the fifth year after the date of the conversion.

10% Penalty Exceptions are as follows:

You have un-reimbursed medical expenses that exceed 7.5% of your adjusted gross income.
You are paying medical insurance premiums after losing your job.
The distributions are not more than your qualified higher education expenses.
The distribution is due to an IRS levy of the qualified plan.
The distribution is a qualified reservist distribution.
The distribution is a qualified disaster recovery assistance distribution.
The distribution is a qualified recovery assistance distribution.

If the distribution that you take from your Roth IRA is greater than the amount of all of your contributions and conversions (regardless of the age of the conversions), then these amount which are earnings, capital gains, interest or dividends will be subject to both penalty and ordinary income tax. The amount of the gain will be added to your income and taxed exactly as if you received it via a regular paycheck.

You should also know that for Roth IRA taxation rules to apply, you must aggregate all of your Roth IRAs and consider them all as one single IRA account. When applying each of the above rules, the IRS views all of your Roth IRAs together as one big Roth IRA. For example, once you’ve met the 5-Year Rule for one of your Roth IRAs, you’ve met it for all of them. Also, distributions from a Roth will not count as distributions of earnings until you’ve withdrawn an amount greater than the total of all of your contributions to all of your Roth IRAs. For example, you contribute $2,000 to a Roth in 2006 and then in 2007 you open a separate Roth and contribute $3,000 to it. Let’s say by 2008 each Roth account has grown to $7,000. You could withdraw $5,000 from either (but not both) of the two Roth IRAs without having to pay taxes or penalties because your total contributions were $5,000 and because the IRS considers them to be one Roth IRA.