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Roth IRA Withdrawal Rules For Self-Directed Accounts

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  |  By Matthew White, CISP

Using a Roth IRA, you can save for retirement by making contributions[1] with after-tax dollars, allowing the investments in your retirement account to grow tax-free[2]. However, when you’re ready to take funds out of your account, it’s important to understand Roth IRA withdrawal rules. While you can generally make Roth IRA withdrawals tax- and penalty-free after the age of 59 ½, there are exceptions to these rules.

In addition, nuances are often involved when taking Roth IRA distributions from self-directed accounts because self-directed IRAs often hold alternative assets, which are not always easy to liquidate.

Below is a summary of Roth IRA withdrawal rules from the IRS, which vary based on your age and how long your account has been opened. (Learn more about traditional IRA withdrawal rules for self-directed IRAs in this previous blog post.)

Roth IRA withdrawal rules: Contributions

Because you paid taxes prior to contributing funds to your Roth IRA, the IRS allows you to withdraw the exact amount of your contributions at any time without having to pay a tax or penalty. However, it’s critical to understand that this only applies to the aggregated amount of contributions you’ve made to all your ROTH IRAs  – it does not include a withdrawal of earnings on your investments, converted contributions, or rollovers of Designated ROTH 401(k). A withdrawal of earnings, converted funds, or rollovers of Designated ROTH 401(k) could be subject to a 10% early withdrawal penalty if you are younger than 59½ and your Roth IRA is less than five years old.

The Roth IRA 5-year rule

The length of time your Roth IRA has been opened and funded helps determine if you will face taxes or penalties on any Roth IRA distributions. A Roth IRA withdrawal counts as a “qualified” distribution if it is made after the 5-year period beginning with the first taxable year for which a contribution was made to

a Roth IRA set up for your benefit.  So if you open your first Roth IRA and make an initial contribution for the 2016 tax year in March of 2017, your five year period begins 1/1/2016.   2If you have multiple Roth IRAs, this rule looks at all of your Roth IRAs to determine when/if the 5-year rule is satisfied.  There is also a separate 5-year rule related to each Roth conversion and rollover contribution.  Refer to IRS Publication 590-B for more detail.

Roth IRAs and the importance of age 59½

Whether or not you pay taxes when you take a distribution on the earnings in your Roth IRA depends not only on the age of the account, but also on your age. Many Roth IRA withdraw penalties are triggered if you take a distribution before the age of 59½.

Non-qualified distributions vs. qualified distributions

Roth IRA distributions taken from your IRA earnings prior to age 59½ and before your account is five years old will likely be considered “non-qualified distributions.” These Roth IRA earning distributions may be subject to taxation and a 10% penalty.

However, you may be able to avoid penalties if:

  • You are 59½ or older
  • The withdrawal is being used to buy or rebuild a first-home
  • The withdrawal is being used to pay for unreimbursed medical expenses
  • The withdrawal is paying for health insurance if you’re unemployed
  • The withdrawal is made in substantially equal periodic payments
  • You've become disabled
  • The distribution is being taken by your beneficiary or your estate[3]

If you take a Roth IRA distribution from your earnings and you are 59½ or older, and your Roth IRA has been open five years or longer, the distribution will be considered to be “qualified.” This means the distributions are not subject to taxes or penalties.

Roth IRA distributions: Nuances for self-directed accounts

Roth IRA withdrawals can be tricky for investors who own a self-directed Roth IRA that is invested in an illiquid asset such as real estate or private stock. If a Roth IRA owner cannot sell an alternative asset investment to make a withdrawal, the typical solution is to take a "distribution in-kind."

For instance, if you own private stock and want to take a distribution but the stock cannot be sold for cash, you can take a "distribution in-kind.” This means you take the distribution in the form of private stock company rather than cash.

If your ROTH IRA owns real estate, you can also take a distribution in-kind instead of selling the property. You can distribute part of the property to yourself via grant deed, which effectively means your ROTH IRA will own part of the property and you will own the percentage that has been distributed.  Any transaction (such as a distribution) that is reportable on IRS tax form 1099-R must be processed with a current valuation.  This valuation can be provided by the asset sponsor or in case of real estate, a current appraisal. 

Also, unlike traditional IRAs, Roth IRAs do not require account holders to take annual required minimum distributions - you are not required by the government to take distributions from your Roth IRA at any age.  However, the required minimum distribution rules may apply to beneficiaries who inherit Roth IRAs. In general, the rules regarding distributions to beneficiaries of IRAs are the same whether an IRA is a traditional or Roth IRA.  Please see IRS publication 590-B or talk to your tax advisor for more information.

As this blog demonstrates, Roth IRA withdrawals can be tricky and they can also have serious financial consequences. A financial advisor or tax professional can help you determine when it makes the most sense to request Roth IRA withdrawals, how much to withdraw and if you may face any taxes or penalties for taking funds out of your account.

If you have questions about how to request a distribution from your PENSCO self-directed Roth IRA, you can contact us at 800.962.4238. The IRS also provides information on its website about Roth IRAs withdrawal rules.

[1] There are IRS rules related to compensation and income limits that apply to your eligibility to contribute to a Roth IRA.  Please consult with your tax advisor or IRS Publication 590-A for more information about whether or not you qualify.

[2] Tax free earnings are dependent upon compliance with IRS rules for withdrawals from Roth IRAs, which are outlined in this article.

[3] If the 5 year rule has not been met, earnings may be subject to taxes.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.