Finance
Qualified Withdrawals from a Roth IRA for Kids | Mora
December 16, 2024
A Roth IRA for Kids is one of the most flexible savings tools available, offering tax-free growth and a variety of withdrawal options tailored to your financial needs.
Understanding the rules for qualified withdrawals, early withdrawal exceptions, and the five-year rule is essential for making informed decisions and maximizing your Roth IRA for Kids' benefits.
In this guide, we’ll cover:
- Contributions vs. Earnings: What You Need to Know
- What Qualifies as a Tax-Free Roth IRA for Kids Withdrawal?
- Early Withdrawals: What to Expect
- Penalty-Free Exceptions for Early Withdrawals
- Advantages of Qualified Roth IRA for Kids Withdrawals
Why Choose a Roth IRA for Kids?
A Roth IRA for Kids offers unparalleled flexibility and tax-free growth, making it a standout option for securing your child’s financial future. Here’s why it’s the ultimate choice:
- Tax-Free Growth: Gains grow entirely tax-free, ensuring your kid's keeps 100% of their hard-earned money.
- Penalty-Free Access for Key Life Events: From education to buying a first home, funds can be accessed penalty-free for qualified expenses.
- No Required Minimum Distributions (RMDs): Unlike traditional IRAs, Roth IRA for Kids don’t require mandatory withdrawals, allowing your savings to grow indefinitely.
- Compounding Power: Starting early amplifies growth, turning small contributions into substantial wealth over time.
Learn more about Roth IRA for Kids' in our article ‘Why a Roth IRA is the best US Savings Account for Kids’.
Contributions vs. Earnings: What You Need to Know
When withdrawing funds from a Roth IRA for Kids, it’s important to distinguish between contributions and earnings. These two components have different withdrawal rules:
Contributions
- Contributions to a Roth IRA for Kids are made with after-tax dollars, meaning you’ve already paid taxes on the money.
- You can withdraw contributions at any time, for any reason, tax and penalty-free regardless of your age or how long the account has been open.
Example: If your kid has contributed $15,000 to their Roth IRA for Kids, they can withdraw that $15,000 anytime without facing taxes or penalties.
Earnings
- Earnings (growth your contributions generate) have stricter withdrawal rules.
- Withdrawals of earnings are tax and penalty-free only if they qualify under specific conditions.
Example: If your Roth IRA for Kids has $15,000 in contributions and $5,000 in earnings. The account has been open for less than 5 years and they withdraw the $5,000 in earnings, they’d owe income tax on that amount and a 10% penalty. Unless it qualifies for an exception, such as higher education expenses or unreimbursed medical bills. However, if the account has been open for 6 years and they’re 60 years old, the $5,000 in earnings could be withdrawn completely tax and penalty-free.
What Qualifies as a Tax-Free Roth IRA for Kids Withdrawal?
To withdraw earnings tax- and penalty-free, you must meet two key criteria:
- The account has been open for at least 5 years (the "five-year rule").
- The clock for the five-year rule begins on January 1 of the tax year of the first contribution, regardless of when the contribution was made during the year.
- One of the following conditions is met:
- The account holder is 59½ or older.
- The withdrawal is for a first-time home purchase (up to a $10,000 lifetime limit).
- The account holder is disabled.
- If the account holder passes away, the funds can be withdrawn by beneficiaries completely tax-free, provided the account has been open for at least five years.
Example: If your Roth IRA for Kids is 6 years old and you’re 60, all withdrawals of earnings are tax and penalty-free.
Learn more about Roth IRA for Kids qualified withdrawals in our article 'Qualified Withdrawals from a Roth IRA for Kids'.
Deborah Horwith, CPA, explains when you can withdraw from a Roth IRA for Kids.
Early Withdrawals: What to Expect
If you withdraw earnings before your Roth IRA for Kids meets the 5-year requirement or you don’t meet one of the qualifying conditions, the withdrawal may result in:
- Income Taxes: The earnings portion of the withdrawal is taxed as ordinary income.
- 10% Early Withdrawal Penalty: This penalty applies to the earnings portion unless an exception is met.
However, it’s important to note that contributions remain unaffected. Contributions can always be withdrawn tax and penalty-free at any time, for any reason, regardless of the account’s age or the withdrawal conditions.
Penalty-Free Exceptions for Early Withdrawals
While taxes may still apply, the following conditions allow you to avoid the 10% early withdrawal penalty:
- Qualified Higher Education Expenses: Qualified higher education expenses including tuition, administrative fees charged by the school, the cost of books, supplies, and equipment.
Example: If your kid’s tuition and fees total $20,000, you can withdraw that amount penalty-free from their Roth IRA for Kids to cover these qualified costs.
- Medical expenses: Unreimbursed medical expenses exceeding 7.5% of your adjusted gross income (AGI).
Example: If your AGI is $70,000 and your family incurs $10,000 in medical expenses not covered by insurance, $4,750 (the amount above 7.5% of your AGI) qualifies for a penalty-free withdrawal.
- Health Insurance Premiums During Unemployment: If you’re unemployed and you’ve received unemployment compensation for 12 consecutive weeks under specific conditions.
Example: If your AGI is $70,000 and your family incurs $10,000 in medical expenses not covered by insurance, $4,750 (the amount above 7.5% of your AGI) qualifies for a penalty-free withdrawal.
- Birth or Adoption Expenses: Withdraw up to $5,000 earnings penalty-free within one year of the event.
Example: If you spend $4,000 on adoption agency fees, court costs, and other related expenses, you can withdraw this amount penalty-free.
- Distributions Due to an IRS Levy: If your Roth IRA for Kids is levied by the IRS, penalty-free withdrawals are allowed.
Example: If the IRS levies $7,000 from your Roth IRA for Kids for unpaid taxes, that amount qualifies for penalty-free withdrawal.
The Five-Year Rule for Roth IRA for Kids
The five-year rule is a key factor in determining whether earnings and conversions from a Roth IRA for Kids can be withdrawn tax- and penalty-free. While contributions are always accessible without restrictions, the five-year rule applies differently to earnings and conversions.
Earnings
To withdraw earnings tax-free, you must meet two conditions:
- The Roth IRA for Kids must have been open for at least five years. The five-year clock starts on January 1 of the year you made your first contribution, regardless of when during that year it was made. For example:
- A contribution made in November 2024 would start its clock on January 1, 2024, meaning earnings become eligible for tax-free withdrawal on January 1, 2029.
- You meet one of the following qualifying conditions:
- You are 59½ or older.
- The withdrawal is for a first-time home purchase (up to $10,000 lifetime limit).
- You are permanently disabled.
- The withdrawal is made to beneficiaries after your death.
If these conditions aren’t met, earnings are considered non-qualified withdrawals and may be subject to income taxes and a 10% early withdrawal penalty.
Conversions
Converted funds have their own five-year rule, but this applies only to penalties, not taxes. Taxes on converted funds are paid at the time of conversion, so the five-year clock determines whether the 10% early withdrawal penalty applies. Here’s how it works:
- Five-Year Rule for Conversions: Each conversion has its own five-year period, starting on January 1 of the year the conversion occurred, regardless of when during that year it was made. some text
Example: A conversion completed in July 2022 would be penalty-free starting January 1, 2027.
- Penalty Implications: If you withdraw converted amounts within five years and are under 59½, a 10% early withdrawal penalty may apply, unless an exception is met. However, no additional taxes would be owed since taxes were paid at the time of conversion.
Example: If you converted $10,000 into your Roth IRA for Kids three years ago, withdrawing those funds now may result in a 10% penalty unless you meet an exception, though no additional taxes would be owed.
Advantages of Qualified Roth IRA for Kids Withdrawals
Qualified Roth IRA for Kids withdrawals provide a range of benefits:
- Tax-Free Growth: Withdraw both contributions and earnings without paying income taxes, maximizing long-term growth.
- Penalty-Free Flexibility: Access funds for education, medical needs, or a first-time home purchase.
- Generational Wealth Building: Roth IRA for Kids do not require required minimum distributions (RMDs) during the original owner's lifetime, allowing the account to grow tax-free over time.
Learn more about Tax-Free Growth in our article ‘How Roth IRA for Kids Create Tax-Free Retirement Savings’.
The Roth IRA for Kids Ordering Rules
When you withdraw funds from a Roth IRA for Kids, the IRS requires withdrawals to follow a specific order, known as the "ordering rules." This structure helps minimize taxes and penalties:
- Contributions: Withdrawn first and always tax- and penalty-free.
- Conversions: Withdrawn second. Withdrawals of converted funds made within 5 years may incur a penalty.
- Earnings: Withdrawn last, subject to taxes and penalties unless qualified for an exception.
Why It Matters: By accessing contributions first, you can meet financial needs without impacting the tax-advantaged growth of your earnings. This sequence ensures that contributions are the first to be withdrawn, minimizing the risk of incurring taxes or penalties on earnings. It allows you to leverage the flexibility of a Roth IRA for Kids while preserving the account’s long-term growth potential.
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How Mora Simplifies Roth IRA for Kids Planning
At Mora, we simplify the complexities of Roth IRA for Kids withdrawals, helping you make informed decisions that align with your financial goals. Our services include:
- Expert Guidance: Tailored strategies for penalty-free and tax-free withdrawals.
- Compliance Assurance: Ensuring your withdrawals meet IRS requirements.
- Maximized Growth: Advice on balancing immediate needs with long-term savings.
With Mora, setting up a Roth IRA for Kids isn’t just easy- it’s transformative. Start your kids on the path to financial independence today. Get in touch with the Mora team and take the first step toward securing their future!
FAQs About Qualified Roth IRA for Kids Withdrawals
Q: Can I withdraw Roth IRA for Kids contributions anytime?
Yes. Contributions can always be withdrawn tax- and penalty-free, regardless of age or account duration.
Q: What happens if I withdraw earnings before 59½?
Unless you meet an exception, earnings are subject to income tax and a 10% penalty.
Q: Are first-time home purchases penalty-free?
Yes. You can withdraw up to $10,000 in earnings penalty-free for a first-time home purchase.
Q: Does the five-year rule apply to contributions?
No. Contributions are not subject to the five-year rule and can be withdrawn tax- and penalty-free at any time.
Ready to get started? Let Mora’s experts simplify the process. Contact us today!
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