The Rules on Closing out a Roth IRA

Closing your Roth IRA early has adverse tax consequences.

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Roth individual retirement accounts let you make after-tax contributions with the promise of tax-free distributions in retirement. When you make contributions using income that has already been taxed, when you go to receive these funds you will not be taxed on this again. Roths make the most sense for people who anticipate paying a higher tax rate in their later years. The IRS rules permit you to close out your Roth IRA any time, but it discourages early withdrawals with additional taxes and penalties.

Qualified Withdrawals

If you can take a qualified withdrawal, closing your Roth IRA won't cost you anything on your taxes other than the ink used to report the amount of the withdrawal because it all comes out tax-free. To take a qualified distribution, you must be 59 1/2 or older, permanently disabled or taking out up to $10,000 to spend on a first home. In addition, at least 5 years must have passed between the start of the tax year you made your first contribution and the withdrawal. Suppose you made your first contribution in the 2018 tax year: your 5-year waiting period starts on Jan. 1, 2018, regardless of when you put in the money.

Early Closeouts

If you close out your Roth IRA when you're not eligible to take a qualified distribution, you'll likely have some taxes to pay. You'll get your contributions in the account out tax-free and penalty-free because you never got a deduction to begin with. But, your earnings will be taxed and hit with the 10 percent early withdrawal penalty unless an exception applies. For example, say you've put $40,000 in your Roth IRA and it's worth $52,000 when you close it. The first $40,000 comes out tax-free, but the last $12,000 count as taxable income and is hit with the 10 percent early withdrawal penalty.

Penalty Exceptions

Exceptions can be divided into two categories: total exceptions, which exempt your entire distribution from the early withdrawal penalty regardless of how much you take out, and partial exceptions, which apply to a specific dollar amount depending on your expenses. Total exceptions include if you're permanently disabled or are taking a qualified reservist distribution. Partial exceptions apply to the portion of your earnings used to pay for medical insurance premiums while unemployed, higher education expenses or up to $10,000 for first-time homebuyer expenses.

Changing Your Mind

If you have a change of heart, you better act fast. After you take the distribution from your Roth IRA, you only have 60 days to put the money back in with a rollover. After 60 days have passed, your withdrawal is permanent. However, if you've already done a rollover to or from the Roth IRA in the last 12 months, you can't put the money back because you're limited to one rollover per account per 12-month period.