In the event a premature distribution is made from a Roth IRA to a taxpayer, the distribution will be subject to a 10 percent penalty of the amount that must be reported as a taxable distribution.
Explaining the Penalty
If an individual had contributed $10,000 to a Roth IRA and the value of the account was $15,000, the difference between the two ($5,000) would be considered earnings. If the individual chose to withdraw all of the Roth IRA funds and the withdrawal did not meet the requirements of a qualified distribution, the distributed earnings would be includible in income. If the withdrawal occurred before the owner’s age of 59 and a half, a premature distribution would result in a tax penalty of $500.
Of the $15,000 in the Roth IRA, $10,000 would be received tax free as a return of after tax contributions. The $5,000 balance is taxable earnings which must be reported to the IRS. Since the Roth IRA owner must report $5,000 of premature withdrawal, the tax penalty is 10 percent of the taxable amount, or $500.
Exception to Roth Penalty
The penalty for a premature distribution from a Roth IRA is waived if the distribution is:
1. Attributable to the IRA owner’s death or disability
2. The distribution was made for medical care to the extent allowable as a medical expense deduction
3. The distribution was made by unemployed individuals for the payment of health insurance premiums
4. The distribution was used to pay qualified educational expenses
5. The distribution was used to make a first time home purchase
6. Part of a series of substantially equal periodic payments made for the life or life expectancy of the individual or of the individual and a designated beneficiary
As you can see there are many exceptions for which the IRS allows a taxpayer to make premature distributions. A taxpayer can anticipate using the money in the future for something that is essential and know they will not be penalized for doing so.