When it comes to Roth IRA withdrawals, timing is everything. You can withdraw your Roth IRA contributions at any time and owe no taxes or penalties. And once you turn 59½ and your Roth is at least five years old, your withdrawals of both contributions and earnings will count as qualified distributions, making them free of taxes and penalties.

But what happens if you withdraw earnings that don’t count as a qualified distribution? Here’s what you need to know.

Key Takeaways

  • You can withdraw your Roth IRA contributions at any time tax-free and penalty-free.
  • Any earnings you withdraw are considered "qualified distributions" if you’re 50 or over and the account is at least five years old, making them tax- and penalty-free.
  • Other kinds of withdrawals are "non-qualified" and can result in both taxes and penalties.

What Is a Qualified Roth IRA Distribution?

A qualified distribution from your Roth IRA allows you to avoid taxes and the 10% early withdrawal penalty. To count as qualified, the distribution must meet both of these requirements:

(1) It occurs at least five years after you opened and funded your first Roth IRA (even if you’re withdrawing from a different one), and

(2) You take the distribution under one of these circumstances:

  • You’re at least 59½ years old.
  • You have a disability.
  • The payment is made to your beneficiary or to your estate after your death.
  • The money is used to buy, build, or rebuild a home as a first-time homebuyer.

You can qualify as a first-time homebuyer even if you’ve owned a home in the past. As far as the Internal Revenue Service (IRS) is concerned, you’re a first-time homebuyer if, “you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse also must meet this no-ownership requirement.”

What’s more, you can use the money from your Roth IRA to help out a child, grandchild, or parent who meets the first-time homebuyer definition. No matter who benefits, you can withdraw a lifetime maximum of $10,000 under the first-time homebuyer exception.

What Are Non-qualified Roth IRA Distributions?

Withdrawals that don’t fit the criteria above are generally classified as non-qualified Roth IRA distributions.

Non-qualified distributions are subject to taxes plus an additional 10% penalty. You may be able to avoid the 10% penalty if one of these exceptions applies:

In addition, you may be able to avoid the 10% penalty if the distribution is:

  • Due to an IRS levy of the qualified plan
  • A qualified reservist distribution
  • A qualified disaster recovery assistance distribution

All other withdrawals from a Roth IRA that do not meet these criteria are considered non-qualified distributions. You’ll owe taxes and an early withdrawal penalty on any non-qualified funds you withdraw.

Ordering Rules for Roth IRA Withdrawals

The IRS treats withdrawals from a Roth IRA in a specific order. When you withdraw money from any of your Roth IRAs (if you have several accounts), the distributions are ordered as follows:

  1. Regular contributions
  2. Conversions and rollover contributions, on a first-in, first-out basis
  3. Earnings on contributions

Remember: You can withdraw your contributions at any time, for any reason, without owing taxes or a penalty. But after you've withdrawn the total amount of your contributions, your next withdrawals will come from your conversions and rollovers, and, finally, your earnings. Those withdrawals, unless they're qualified, can trigger taxes and penalties.

Taking a non-qualified distribution from your Roth IRA not only results in taxes and fees now but means you'll have less money to rely on after you retire.

What Happens If I Take a Non-qualified Roth IRA Distribution?

Non-qualified Roth IRA distributions are taxed as ordinary income. In addition, you’ll have to pay a 10% early withdrawal penalty if you are younger than 59½. These can add up to a considerable sum, with the potential to erode 30% to 50% of your investment, depending on your tax bracket at the time of withdrawal.

Holding your Roth IRA funds until retirement is, needless to say, the best approach financially. But if you do have to take an early distribution, understanding the rules that determine whether it is qualified or non-qualified can minimize the amount of taxes and penalties you may have to pay.

Of course, it’s important to remember that any money you take out of your Roth early is less money you’ll have during retirement. And that’s not just dollar-for-dollar. You’re losing out on potentially years of compounding. So in general, it should be viewed as a last resort.