Using Roth IRA Funds to Pay Off Debt

A reader name Sam recently wrote in to ask about using Roth IRA funds to pay off debt. Here’s his question:

I have around $19, 500 in a Vanguard Roth IRA. I need a new roof (which will cost $5, 200) and I would also like to pay off credit card debt of $10, 000. What is the maximum I can take out to do this?

For the sake of this post, I’m going to set aside the issue of whether or not it’s a good idea to raid your retirement account for expenditures like this. Instead, I’ll focus on the ins and outs of withdrawing funds from a Roth IRA.

For starters, I’ll assume that Sam hasn’t yet reached 59.5 years old. If he has, then he’s free to withdraw as much as he wants from his Roth IRA without facing any taxes or penalties.

I’m further assuming that Sam wants to avoid paying unnecessary taxes or penalties on his withdrawal.

To answer this question, we need to consider the types of money that are present within Sam’s Roth IRA. There are three possibilities here: plain old contributions, conversions, and earnings.

As it turns out, you can withdraw your Roth IRA contributions at any time without paying taxes (you’ve actually already paid taxes on this money) or penalties.

For conversions — this is money that started out in a traditional IRA and was later converted into a Roth account — the rules are a little different. For the most part, conversions are treated like contributions, except that you will have to pay a 10% penalty if you withdraw these funds less than five years after the conversion event.

This rule stops people from converting money to a Roth account simply to gain immediate access to it. There are, however, no additional taxes when you do this because you’ve already paid taxes on that money — either when you made the original contribution (for non-deductible contributions) or when you did the conversion (for deductible contributions).

And finally… Earnings.

Any earnings that are withdrawn less than five years after you established your Roth IRA are subject to income taxes. In addition, if you’re under age 59.5 when you make the withdrawal, it will be taxable and subject to a 10% penalty. Once you hit 59.5 and have satisfied the five-year rule, you can withdraw your earnings without any taxes or penalties.

Exceptions to the above rules include distributions made to a beneficiary after your death, disability, and/or using the funds to pay certain costs associated with being a first-time homebuyer. But these don’t appear to apply in Sam’s case.

So… The answer to Sam’s question is: it depends. He can access his prior contributions right now, funds that he converted five or more years ago, and earnings once the account is at least five years old and he’s reached 59.5 years of age. If he does anything other than this, he’ll face taxes and/or penalties.

3 Responses to “Using Roth IRA Funds to Pay Off Debt”

  1. Nickel

    Brien: It’s widely recognized that contributions can be withdrawn tax free. The IRS distinguishes between qualified distributions and distributions which are a return of your contributions, in saying:

    “You generally do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA.”

    That’s from Publication 590, and they further address this point in the section on ordering your distributions.

    Also, if you look at Form 8606, you’ll also see that Roth contributions are subtracted (line 22) when calculating how much of your distribution is taxable.

    What I’ve written above is an accurate summary of the guidelines. Please read Publication 590 and work some examples on Form 8606 if you’re in doubt.

  2. Anonymous

    For some reason I thought the account had to have been open for five years in order to do this but I could be wrong… Regardless I know you can withdraw contributions tax/penalty free you just have to make sure you follow the rules.

  3. Anonymous

    Some Roth IRA distributions will be subjected to taxes and penalties, even if they are only distributions of the contributions (rather than distributions of the contributions and earnings).

    Please look up the term “qualified distribution” in relation to a Roth IRA and/or talk to a specialist who can offer legal or tax advice before following the suggestions outlined in this original post.

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