Invest Retirement

Need Cash From Your Retirement Savings? Tap Into a Roth IRA First

Dayana Yochim  |  March 24, 2020

If you’re in dire need of cash, the Roth IRA early withdrawal rules make it a better option than other retirement savings accounts.

Under normal circumstances the standard financial advice is to leave your retirement savings invested for retirement. But these aren’t normal times.

Those who have burned through their emergency savings, tapped out loans and are running on credit cards and fumes may have no other option for cash than to take an early withdrawal from a retirement savings account. In most cases, the IRS slams you with some pretty harsh early withdrawal penalties and income taxes for cashing out these tax-advantaged retirement accounts early.

Roth IRA early withdrawal rules are different. 

Roth vs. Traditional IRA Early Withdrawals 

The Roth IRA is built for times like these because the IRS allows you to withdraw your contributions (not earnings) at any time without paying taxes or penalties. That’s one of the biggest advantages to a Roth IRA versus a traditional IRA

Early withdrawals from a traditional IRA — contributions and/or earnings — are subject to a 10% early withdrawal penalty. On top of that, you’ll pay income taxes on the amount you take out. 

Another Roth IRA bonus: A Roth provides tax-free investment growth on the money in the account: Since contributions are made with after-tax dollars (meaning the IRS has already taken its cut), you pay no taxes on any investment gains — none while the money is in your Roth, and none down the road when you withdraw those earnings in retirement. In a traditional IRA, investment growth within the account also isn’t taxed, but withdrawals in retirement are. 

Roth IRA Early Withdrawal Strategies 

If it gets to the point where you need to start tapping the money from your Roth IRA to cover your must-pay expenses, be careful about which dollars you choose to withdraw. These guidelines will help you minimize long-term damage to your retirement savings:

  • Concentrate on contributions. IRS rules are very clear on a Roth IRA early withdrawal: You’re allowed to take out money you contributed to the account at any time and for any reason. Roth investment earnings are a different story. The only way to skirt the 10% Roth early withdrawal penalty and taxes on earnings is if you are age 59 ½ or older and the account has been open for at least five years, and under very specific circumstances outlined by the IRS — including getting money to pay for higher education expenses or medical bills.
  • Access cash first. When you deposit money in a Roth IRA without directing how it’s invested, your cash will be held in a low-interest money market account. Taking an early withdrawal from these dollars first leaves money invested in other assets more time to recover from recent losses.
  • Tap investments in this order. If you have to start cashing out your Roth IRA investments, Jim Royal, investment expert at Bankrate.com, recommends starting by harvesting any cash from bonds or bond funds and, if necessary, selling the actual bonds or funds that have had the lowest price movement. If you have to liquidate stocks or stock-based funds, sell those with limited upside and hold on to any stocks still paying dividends. The idea is to let investments that have the best chance of recovery and those that generate cash ride it out for as long as possible. 
  • Dollar-cost average out of your investments. Instead of selling assets all at once, you can protect yourself against some market volatility by withdrawing smaller chunks of money as you need the cash. By spreading out your sales you’re more likely to avoid selling at a low point.

There’s No Downside to Opening a Roth IRA Right Now

If you don’t have a Roth IRA, or you haven’t yet contributed to one for the 2019 tax year, now’s a good time if you have some cash you want to stash. (We put together an explainer to help you decide where to open an account.)

The maximum Roth IRA contributions allowed for the 2019 and 2020 tax year are $6,000 if you’re under 50 and $7,000 if you’re 50 or older. How much you’re allowed to save is based on your modified adjusted gross income and starts to phase out at higher income levels. Like the 2019 tax filing deadline and payment due date, the deadline to contribute to an IRA for the 2019 tax year has been extended to July 15. 

Although the Roth IRA is designed to help savers invest for retirement, keep in mind that there’s no requirement for you to invest your Roth contribution in the market right away (or at any time). Your deposit will automatically go into a money market sweep account and remain there until you deploy it. That puts you in the perfect position to inch back into the stock market while prices are low if you don’t end up having to crack open the account for emergency cash.

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