Tax-Free Roth IRA Withdrawal Options

Tax-Free Roth IRA Withdrawal Options – What every Roth IRA account holder should know

While Roth IRAs are funded in after-tax dollars, making a mistake on fund withdrawal could still subject you to tax and penalties on withdrawal of earnings. Here are some tips.

You must take care to plan your retirement plan withdrawals to avoid a potential 10% early withdrawal penalty. Unfortunately, each retirement account type has different rules. Here are some tips for Roth IRAs.

Roth IRA basics

Roth IRA accounts differ from other IRAs in that your contributions are made in after-tax dollars. If you follow the Roth IRA rules, your withdrawals of any earnings in the account can be tax-free. Generally, to take advantage of the tax-free distribution from a Roth IRA:

  • You must be age 59 ½ or older.
  • You must have had funds in the Roth IRA account for more than 5 years.
  • You must understand what is being distributed (contributions, converted funds or account earnings).
  • You must know your possible tax-free distribution options.

If you do not comply with these rules you could be subject to income tax and a 10% early withdrawal (distribution) penalty. But wait! There are ways to avoid income tax and the early withdrawal penalty.

Roth IRA distribution tips

  • Remember contributions have been taxed. What many forget is that your initial contributions have already been taxed. The portion of your early distribution from a Roth IRA account subject to income tax is only the untaxed earnings on your contributions.
  • 10% early withdrawals. Early withdrawal penalties are subject to the five year account rule and how you use the funds when distributed. It also might depend on what funds you remove from your account. Prior to withdrawing funds, ask for help to ensure you know whether you will be subject to the early withdrawal penalty.
  • Qualified early withdrawals. If you use the distributions for a qualified reason, you can avoid the early distribution penalties. Some of the more common qualified early withdrawals with Roth IRA’s are:
    • College. If you withdraw Roth IRA earnings to pay for college expenses, you will pay tax on the earnings withdrawn, but you will not be subject to the 10% early withdrawal penalty.
    • First-time home buyer. Even if you’ve had your Roth IRA for less than five years, you can withdraw up to $10,000 in Roth IRA earnings income tax-free and penalty tax-free if it is used to buy a first home.
    • Account holder disability or death.
    • Unreimbursed medical expenses that exceed your itemized deduction threshold.
    • Substantially equal periodic payments. These must be made over the defined life-expectancy of the IRA holder using specific rules to avoid the early withdrawal penalty.
  • No minimum withdrawal requirements. Unlike other IRAs, the Roth IRA does not require you to take money out when you reach a certain age. With Traditional IRAs this withdrawal requirement occurs when you reach age 70 ½. This means you can have a strategy to never withdraw the funds in your Roth IRA as an estate-planning device. While the funds would be considered part of your estate, your heirs could withdraw the funds tax and penalty-free during their lifetime.
  • Keep separate accounts. The taxability of a withdrawal can be complicated. Are you withdrawing contributions, converted funds, or earnings? How long have the funds been in the Roth IRA? Because this can be complex, try to keep your Roth IRA accounts simple. If you convert funds from another retirement account into a Roth IRA, do so in a separate account. It will then be easier to understand the impact of a withdrawal from the account.

If you have questions regarding your situation, speak to a qualified planner prior to taking any withdrawals from a Roth IRA or other tax advantaged retirement plan. It could save you plenty in potential tax and penalties.

Your income

Tax-Free Rental Income

Did you know you can rent out your home or vacation property for up to 14 days and not need to claim the income? Here are some tax tips to take advantage of this opportunity.

Most income you receive is taxable income that is reported to you and to the Federal/State tax authorities. However, there are a few income-producing events that the IRS has said are not taxable. One of them is renting out your home or vacation property.

The rule: If you receive rental income for less than 15 days per year, that income is generally not taxable income.

Added benefit: In addition to tax-free rental income, you may still deduct your mortgage interest expense and property taxes as itemized deductions. Neither of these tax benefits is reduced with the income from up to two weeks of rental activity.

Would someone want to rent your property?

Sure it sounds good, but why would someone want to rent your property? Here are some ideas:

A sporting event. If a big sporting event is in town, consider renting out your home for participants and fans. Common examples include;

  1. Football games
  2. Golf tournaments
  3. State high school tournaments
  4. College football and other college events
  5. Host foreign students/teachers

Rent out your vacation home. If you have a cabin or cottage, consider renting out your place for two weeks. If you find responsible renters, you may have an opportunity to find reliable repeat renters each year.

Vacationer alternative to hotels. Often times travelers from other cities and countries would love to rent out homes or rooms within homes while traveling. This lets these travelers have a real “local” experience versus staying in a hotel.

Know the risks

The hassle factor needs to be considered prior to taking advantage of this free income opportunity. You should also understand the risks involved. Having a proper rental agreement, damage deposit, and insurance are key factors to consider. Also remember to only rent out your property for up to 14 days. Rent received beyond this is taxable and rental income rules apply.

Thankfully there are a number of internet sites that can help you navigate through your options. Here are a couple popular sites to find out more information.

Vrbo.com (vacation rentals by owner)

Tripadvisor.com (includes personal rentals with user feedback)