Are Roth IRA Distributions Taxable?

Part of the reason you invested in a Roth IRA is for the tax advantages – otherwise, you would have gone with a traditional IRA! However, the taxation of your Roth IRA contribution and distribution schedule can get quite confusing. Are Roth IRA distributions taxable? And if so, when are Roth IRA distributions taxable?

Below, we’ll answer both these questions and many others you may have about Roth IRAs. By the end of our discussion, you’ll feel more confident in navigating how you pay taxes on Roth IRAs. So – let’s get started with a quick overview of what this type of retirement account is, and how it differs from the traditional IRA.

What is a Roth IRA?

IRA stands for Individual Retirement Account. A Roth IRA is a type of account that allows qualifying Roth IRA withdrawals that meet certain conditions to be tax-free. A Roth IRA is different from a Traditional IRA mainly in how you pay taxes on it.

A Roth IRA is funded with after-tax dollars. What does that mean? Well, Roth IRA contributions are not tax-deductible but once a person starts taking out funds, then they will be tax-free. The money in these accounts will grow tax-free as well.

It’s important to note that a Roth IRA account is also less restrictive than other retirement accounts. That’s because the Roth IRA holder can maintain the Roth IRA forever, and there are no required minimum distributions (RMDs).

Understanding Roth IRA Distributions

Let’s take a deeper look at Roth IRA distributions. Roth IRA distributions are also known as Roth IRA withdrawals. You can take out Roth IRA contributions from your Roth IRA without having to worry about taxes and penalties.

For example, if you withdraw the same amount of money that you have deposited, then the distribution (the amount you take out) is not considered taxable income. On top of that, it is not subject to penalty no matter how old you are or how long you had the funds in the account. However, there are two types of distributions – and that’s where things get tricky.

Are Roth IRA Distributions Taxable?

We want to answer the question, “are Roth IRA distributions taxable?” as clearly as we can! As we said earlier in this article, Roth IRA distributions are often tax-free. However, that is only if they are qualified distributions.

What Types of Roth IRA Distributions are Tax-Free?

In order for a Roth IRA distribution to be considered tax-free, the distribution will need to have occurred at least 5 years after the Roth IRA holder created and funded their first Roth IRA. On top of that, the distribution must also happen under at least one of the following examples:

  • The Roth IRA holder is at least 59 years and 6 month old when the distributions happen.
  • Assets that are distributed are used towards building, buying, or rebuilding a first home for the Roth IRA holder or an eligible family member. Eligible family members include the Roth IRA holder’s spouse, a child of the Roth IRA holder, a child of the Roth IRA holder’s spouse, a grandchild of the Roth IRA owner, etc. (the limit is $10,000 per lifetime).
  • The distribution happens once the Roth IRA holder becomes disabled.
  • Assets that are distributed to the beneficiary of the Roth IRA holder once they pass away.

When are Roth IRA Distributions Taxable? (Non Qualified Distributions)

If they are not qualified distributions then it is a different story. Non-qualified distributions that do not meet the conditions listed above may have to deal with income tax and/or a 10% early withdrawal penalty:

  • Unreimbursed Medical Expenses: The distribution must exceed 7.5% of the person’s adjusted gross income (AGI) for the 2021 tax year (and tax years prior).
  • Paying Medical Insurance: Only if the person lost their job.
  • Towards Qualifying Higher Education Costs: Qualifying higher education costs include tuition, fees, supplies, books, and more for the Roth IRA holder and/or their dependents. Eligible items must be a requirement in order to enroll or attend as a student at a qualifying educational institution. The funds must be used in the year that they are taken out!
  • Towards Adoption Expenses or Childbirth Expenses: Only if the distribution was made within one year of the event and is not over $5,000.
  • What are Substantially Equal Periodic Payments?

Unless you are eligible for an exception, taxable amounts that you take out of an IRA or qualifying retirement plan before the age limit of 59 year and 6 months old may deal with the taxes and penalties we listed above. However, there are exceptions to these tax penalties. One exception involves taking a series of “substantially equal periodic payments” (SEPPs) from your IRA.

These payments are funds that you must take out of your IRA. You must use an IRS-approved distribution method and take at least one distribution every year. There are multiple IRS-approved methods for figuring out the amount of these payments that rely on factors like your life expectancy (amongst other factors). The payments must continue until you are at least 59 years and 6 months old or for at least 5 years, whichever is later.

Wrapping Up Our Discussion on if Roth IRA Distributions are Taxable

So – are Roth IRA distributions taxable? We hope you gained clarity on this subject today after reading our article. As you can see, the answer is not one size fits all. You’ll have to ponder your unique situation to determine which contributions are taxable. This is part of the challenge of Roth IRAs – but they obviously have their benefits, too!

In summary, certain Roth withdrawals are tax-free – you pay taxes when you contribute to a Roth. But in order for a distribution to qualify for tax-free treatment, it will need to have happened at least 5 years after the Roth IRA holder created and funded their first Roth IRA. On top of that, the distribution must also occur under at least one of the following:

  • The Roth IRA holder is at least 59 years and 6 months old when the distributions happen.
  • Assets that are distributed are used towards building, buying, or rebuilding a first home for the Roth IRA holder or an eligible family member. Eligible family members include the Roth IRA holder’s spouse, a child of the Roth IRA holder, a child of the Roth IRA holder’s spouse, a grandchild of the Roth IRA owner, etc. (the limit is $10,000 per lifetime).
  • The distribution happens once the Roth IRA holder becomes disabled.
  • Assets that are distributed to the beneficiary of the Roth IRA holder once they pass away.

Want to learn more about Roth IRAs? We have articles on the Roth vs traditional IRA income limits, or which is better – traditional or Roth IRA? Or, learn about the 401k vs IRA account debate. Explore our blog to learn all about investing and retirement planning!

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