Today, I’m going to address a question I get quite often. “Outside of knowing I want to retire one day, I don’t really have any set goals. Which investment account should I prioritize?” Most often my answer will be the Roth IRA. The Roth IRA is designed to help you with your retirement through tax-advantaged after-tax benefits. But the Roth IRA is not just for your old age. It’s a great account for any mid-term goals you might have like buying a house, paying for a wedding, supporting your newborn, and more. In the Learn to Invest Course I warned you that taking money out of your Roth IRA before the age of 59.5 may result in additional income tax as well as a 10% penalty. But you actually have the option to access this money early. Let’s unwrap this further… Roth IRA Nugget 1: You can withdraw contributions you made to your Roth IRA anytime, tax and penalty-free for any purpose. So let’s say you contribute $4,000 on January 1st. Your Roth IRA grows to $4,320 by the end of year. At this time, you can take a $4,000 distribution (your original contribution) at any time and not face any extra taxes or penalties. You can use this $4,000 contribution for any expense. There are no rules. You wanna spend $4,000 to expand your rock collection, have a blast! Ok, now let’s say you contribute another $3,000 the following year, and your total portfolio grows to $7,905 by the next year-end. At this time you could access $7,000 tax and penalty free (since both your $4,000 and your $3,000 count as original contributions). Your remaining $905 is your Roth IRA earnings. Ok, so what about earnings? When can I access those? Roth IRA Nugget 2: Your Roth IRA earnings are subject to more rules. Both your age and how you spend your money will impact how you are taxed or if you face a penalty. If you are over 59.5 years: You must wait 5 years* after your first contribution to a Roth IRA to withdraw your earnings completely tax and penalty free. If you haven't met the 5-year holding requirement, your earnings may be subject to taxes but not penalties. If you are under 59.5 years old: You must wait 5 years after your first contribution to a Roth IRA to withdraw your earnings tax and penalty free, BUT ONLY for select expense types:
Use $10,000 ($20,000 for couples) to buy, build, or rebuild your first home
Withdraw $5,000 following the birth/adoption of a child - must be done within 1 year
Pay for eligible college expenses like tuition, books, supplies, room and board
For more challenging financial circumstances:
You are unemployed and need to cover healthcare premiums
You have healthcare costs that insurance won’t cover and they exceed 7.5% of your income
You incur a severe disability and are no long able to work
If you are under 59.5 years old and you don’t wait the 5-year period to spend your earnings, you won’t face the penalty, but you will still face more taxes on those earnings. The below image sums the rules up well:
So there you have it. You have access to your Roth IRA contributions any time, and you have access to earnings under specific situations.
A final important note, if you do decide to take distributions from your Roth IRA in the form of contributions and/or earnings, you are lessening the long-term compounding growth opportunity from your portfolio. For this reason, you would only want to do this for important goals or life events. Remember, when you take distributions from your Roth IRA, you are taking away from your retirement safety net! Take extreme care that you don’t take out too many cookies from the cookie jar, ‘cause you don’t want to go hungry as you reach old age.
Boost your Wallet. Wellbeing. World.
Rebecca
*The five-year period starts on the first day of the tax year for which you made a contribution to any Roth IRA, not necessarily the one you're withdrawing from. So if you contributed to a Roth IRA for the first time in early 2020 but the contribution was for the 2019 tax year, then the five years will end on Jan. 1, 2024.” Motley Fool
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