What Happens If You Withdraw From Your Roth IRA Early?

As mounting financial issues such as rising inflation and socio-economic crises dominate the news cycle, modern workers are placed under unprecedented levels of economic pressure. Because of this uncertainty, building up one's savings has become more important than ever before; especially for those retirement years when you might no longer have access to a stable income. But even if you're one of those financially savvy workers who contribute to their retirement funds in anticipation of their senior years, unforeseen emergencies could push you to withdraw money from your retirement fund early. In order to prepare you for this scenario, let's take a look at the consequences that you may face should you choose to withdraw from your Roth IRA early.

What is a Roth IRA?

Before diving into the deep end, it's important to identify the difference between a Roth IRA and a traditional IRA. A traditional IRA is a retirement investment account where you invest a portion of your salary. Because the money that you are contributing comes before tax, your contributions end up being tax-deductible. A Roth IRA consists of contributions made from after-tax dollars, however, it does have a few advantages that the traditional IRA does not, for example, the account's earnings remain tax-free and you don't pay tax on distributions. Finally, Roth IRA contribution limits are subject to income thresholds while traditional IRA limits are not. Ultimately, if you predict your income bracket will be higher by retirement, then a Roth IRA would be the track for you. If you're of the belief that your income will remain more modest, then perhaps the traditional IRA will be your best bet. Once you've decided which option to choose, it's time to learn about the consequences of withdrawing from your IRA early. After all, unforeseen emergencies may leave you with little choice other than to dip into your savings before retirement.

The consequences of early withdrawal

To fully understand the consequences of early Roth IRA withdrawals, it's important to understand what happens in the case of traditional IRAs as well. While traditional contributions are tax-exempt, withdrawals are considered taxable income, even during retirement. This means that account holders who withdraw their savings regardless of age will pay taxes of 10%. Furthermore, the withdrawal of funds before reaching the age of 59 and a half are subject to early withdrawal penalties of 10%. Once adding these fees together, it becomes clear that early withdrawals from your traditional IRA are not an efficient use of funds. In comparison, Roth IRAs hold a unique advantage when it comes to early withdrawals.

Roth IRA has the edge

Because Roth IRA contributions are made with after-tax dollars, this means that you've already paid tax. As a result, your eventual withdrawals are not taxed (as this would result in double taxation). This means that Roth IRA withdrawals are not subject to income tax, whether they're made before retirement or not. Still, Roth IRA holders are not entirely exempt from penalties should they withdraw their funds early. If you aren't at least the age of 59 and half as well as a Roth IRA account holder for a minimum of five years upon withdrawal, then you'll still be subject to a 10% early withdrawal penalty. That is unless one of the numerous exceptions applies.

Avoiding early withdrawal penalties

As we've mentioned before, life is full of unforeseen financial emergencies. With this in mind, provisions have been made so that early withdrawal fees for Roth IRA holders can be avoided under a few circumstances. First of all, you'll be exempt from penalties if you use the withdrawn funds for a first-time home purchase. You'll also be able to do so if the funds go towards paying unreimbursed medical expenses or health insurance on the condition that you are currently unemployed. Other qualifying expenses are qualified education expenses as well as birth or adoption expenses.