Retirement accounts offer great tax benefits, but to earn them, you generally have to leave your money untouched until you turn age 59 1/2. Withdrawing cash sooner generally triggers a 10% early withdrawal penalty on top of the taxes you could already owe if the money came from a tax-deferred account, like a traditional IRA or 401(k).
There's one account that lets you tap a portion of your retirement savings whenever you want -- although that doesn't mean you should.
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Paying taxes now gives you more freedom later
Unlike most retirement accounts, Roth IRAs are funded with after-tax dollars. This means you'll pay any taxes on your contributions in the year you make them instead of getting an upfront tax deduction. And once you've paid taxes on these funds, you can do whatever you like with them later.
Most workers can set aside up to $7,000 in a Roth IRA in 2024 or $8,000 if you're 50 or older. You can withdraw your contributions at any time to cover emergency expenses or invest it elsewhere if you'd like, but the rules for withdrawing earnings are more complicated.
Taxes and penalties are still possible
You can withdraw Roth IRA earnings tax-free and penalty-free as long as you meet two requirements. First, to avoid the 10% early withdrawal penalty, you must be at least 59 1/2 at the time you withdraw the earnings.
Second, you must have a Roth IRA for at least five years before withdrawing the earnings. The five-year clock begins on January 1st of the year in which you made your first contribution. If you attempt to take the money out before you've held your account for at least five years, you could owe taxes on those earnings, even if you're over 59 1/2 at the time.
If you're under 59 1/2 and you've had your Roth IRA for fewer than five years, you could owe taxes and penalties on earnings withdrawals. There are exceptions to the early withdrawal penalty if, for example, you need the money for a first-time home purchase or because you become disabled.
If you have a qualifying exception and you've had your Roth IRA for at least five years, you'll avoid both the penalty and the taxes. But even a qualifying exception won't help you escape taxes on withdrawn earnings if you've held your Roth IRA for fewer than five years.
Keep in mind that the above rules apply to earnings only. You'll never owe taxes or penalties on withdrawn contributions.
Also, when you withdraw money, the IRS distributes your personal contributions first and your earnings last. So if you have $4,000 in personal contributions and $1,000 in earnings in your Roth IRA and you withdraw $3,000, the IRS will assume it's all personal contributions and you won't owe taxes or penalties on any of it.
But if you withdraw $4,500, only the first $4,000 would be tax-free and penalty-free. The remaining $500 would come from earnings, and you could owe taxes or penalties as outlined above.
Leave your savings alone, if possible
It's nice to have access to some of your Roth IRA savings if you get in a tight financial spot. But it's usually best to leave that money alone if you can.
When you withdraw your retirement savings early, you're not only risking penalties and taxes -- you're also slowing the growth of your retirement savings. You'll probably have to set aside more money going forward or delay your retirement to make up for this.
Whenever possible, explore alternate means of getting the money you need before making a Roth IRA withdrawal. This might include saving up for a large purchase over time or taking out a loan.
If you have no choice but to take money from your Roth IRA, try to limit yourself to contributions only. Then, revisit your retirement plan as soon as you can and decide how you'll alter your saving strategy to keep yourself on track for the retirement you want.
