As mentioned in related posts, there are certain hurdles that you must clear in order for your Roth distributions to be considered “qualified”, and thus tax-free, by the IRS. These rules are a bit different for Roth IRA accounts than for Roth 401k and Roth 403b accounts.
Roth IRA – You can withdraw your contributions (Bucket #1 in your right hand) at any time without paying taxes or a 10% early withdrawal penalty. You better not touch the money you have in Bucket #2 in your left hand (earnings), however, unless you meet the following criteria:
- You are age 59.5 or older AND
- You have had a Roth IRA (any Roth IRA) for at least 5 years.
If you need to access your earnings (Bucket #2) from your Roth IRA before age 59.5, then you may still do so without paying taxes or a 10% early withdrawal penalty if you meet the following criteria:
- You have had a Roth IRA (any Roth IRA) for at least 5 years AND
- You are disabled OR
- You are a first-time homebuyer ($10,000 maximum)
One other note – if you are accessing your earnings (Bucket #2) from your Roth IRA for certain qualified educational costs before age 59.5, then you will owe ordinary income taxes upon the earnings, but you will avoid the 10% early withdrawal penalty as long as you have had a Roth IRA (any Roth IRA) for at least 5 years.
Roth 401k and Roth 403b
Because distributions from a Roth 401k and Roth 403b are prorated between both your contributions and earnings (Bucket #1 and Bucket #2), you cannot withdraw your contributions at any time without paying taxes or a 10% early withdrawal penalty like you can with a Roth IRA. In order to avoid paying taxes or a 10% early withdrawal penalty on a distribution from a Roth 401k or Roth 403b account, the distribution must meet the following criteria:
- The funds must be held for a 5-year period, dating from the earlier of: a) the first year that you contributed to any Roth 401k or Roth 403b account in your employer’s retirement plan OR b) if a Roth rollover contribution is made, the first taxable year in which you made a designated Roth contribution to the other applicable retirement plan AND
- The distribution must be made after you have reached age 59.5 OR
- You are are disabled OR
- Made to your beneficiaries after your death.
[...] Stated simply, the primary benefit of converting to a Roth is that you will never pay tax on the contributions or earnings when you withdraw funds from the Roth account. This assumes that the distribution is deemed “qualified” by the IRS. To learn more about what the IRS considers a qualified distribution from a Roth account, check out this related post. [...]
[...] To better understand the IRS rules defining what is and is not a qualified distribution, check out this related post. [...]