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Taxes and Penalties on Roth IRA Withdrawals

You can always withdraw contributions tax- and penalty-free. It's more complicated when you take earnings.

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I know Roth IRA withdrawals are tax-free after age 59½ as long as you’ve had a Roth for a five-year period. What I don't know is how that five years is calculated.

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First of all, there's no waiting period when it comes to withdrawing amounts you have contributed to a Roth. If you put in $5,000 today, you can reclaim it tomorrow tax- and penalty-free. You’ve already paid tax on the money—which is why there's no deduction for Roth contributions.

The five-year rule comes into play only when you withdraw earnings, and you dip into earnings only after all contributions have been withdrawn. Plus, five years isn't really five years. It begins on January 1 of the year for which you make the IRA contribution (even if it's before the tax-filing deadline in the next calendar year).

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Say you open your first Roth this month and make your 2015 contribution before the tax-filing deadline of April 18, 2016. The five-year period would end on December 31, 2019, after less than four years. After that, you can withdraw earnings tax-free if you’re age 59½ or older. For Roth IRAs opened with contributions (as opposed to converting a traditional IRA to a Roth), as soon as your first Roth passes the five-year test, so do ones you opened later.

The rules are different if you convert a traditional IRA to a Roth. In that case, you have a separate five-year period for each conversion, and that clock starts ticking on January 1 of the year you make the conversion. Withdrawals of converted amounts are always tax-free (you paid taxes when you made the conversion) and are penalty-free if made after you're older than 59½ or the conversion passes its five-year test.

When you do withdraw money from a Roth IRA, the IRS considers the first withdrawals to be from contributions; any withdrawals after that are considered to be from conversions, and then the last withdrawals are considered to be from earnings. For more information about Roth IRAs, see Reap the Rewards of a Roth IRA. See IRS Publication 590-B, Distributions from Individual Retirement Arrangements, for details about the tax rules.

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Got a question? Ask Kim at askkim@kiplinger.com.