There are a number of reasons that people open IRAs. IRAs offer a great deal of flexibility in terms of investments you can include in your account, as well as opportunities for you to choose whether you want to pay taxes on your income now, or later.
Another reason that many people like Roth IRAs, though, is due to the fact that you can withdraw some of your money early, without penalty.
When Can You Withdraw without Penalty?
The very first thing to realize about your Roth IRA is that you can take out your contributions at any time, without any penalty at all. Because you pay taxes on your income before you put it in the Roth IRA, you aren’t getting a tax benefit until later. So, if you put $500 in your Roth IRA today, you can withdraw it next week, without penalty. However, you can only withdraw your contribution money. If you withdraw more money than you contributed, dipping into your earnings, you have to pay your penalties on that portion of your withdrawal.
Qualified Distributions from Your Roth IRA
There are instances in which you can tap into your earnings as well as your contributions. These are cases of qualified distributions from your Roth IRA. These distributions must follow certain rules. One of these rules is the five-year rule. Your Roth IRA needs to have been in effect for five years, beginning with the first taxable year for which a contribution was made. So, in order to make a qualified distribution, you first need to make sure that you qualify under the five-year rule.
Next, you need to meet other requirements. One of those is that you are 59 1/2. You can also take qualified distributions if you are disabled. There is also an exception made for buying a first home. You can take out up to $10,000 (lifetime limit) to help you buy your first home.
Think Twice Before Taking Money from Your Roth IRA
Of course, you need to think twice before taking money out of your Roth IRA. Even if you withdraw money in such a way that you avoid penalty, you still need to be careful. When you withdraw money from your retirement account, you end up with opportunity loss. You are withdrawing principal that is no longer at work for you. Even if you replace the money you withdrew (you have 60 days before it is considered a distribution), you can’t replace the interest that you lost out on due to the time the money was absent from your account.
You can’t replace that time, and it could make a big difference down the road, as you prepare to retire. The Roth IRA is a great financial tool. You have the opportunity for flexibility in your investments, and you have options that aren’t available with other retirement accounts, including the ability to withdraw your contributions without penalty. But you still need to be careful in order to ensure that you are using your Roth IRA to best advantage.