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Investing

Early Withdrawals From a Roth IRA: How to Avoid Penalties

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A Roth IRA is a handy investment tool that lets you contribute pre-taxed funds to the account, allowing your money to grow over time. Taxed contributions mean you won’t pay any taxes when you’re ready to withdraw your money in retirement. In 2019, you can contribute up to $6,000 into a Roth IRA annually if you’re under age 50. It bumps up to $7,000 if you’re over the age of 50 (although income limits apply).

But the other benefit of a Roth IRA is that you don’t have to wait until retirement to take money out. When you use the funds the right way — such as a down payment on a house or to pay for college — you can take an early withdrawal from your Roth IRA without paying any penalties.

“When we’re talking about how to save money and where to put it aside, we’re looking now at the idea that using a Roth is almost a surrogate savings account and college fund and retirement fund,” said Dennis Nolte, a financial planner in Winter Park, Fla.

Understanding earnings vs. contributions

One of the key things to understand about a Roth IRA is that there are two parts to the money within the account: There’s the money you put in (contributions) and the money that grows in the account via investing (earnings). So, if you open a Roth with $5,000 and after two years the money has grown to $6,000, you have $5,000 in contributions and $1,000 in earnings.

It’s important to understand the difference between the two because you can only avoid taxes and penalties by withdrawing your contributions — and not earnings — before the age of 59 and a half. “You can take the principal out tomorrow because it’s already been taxed,” said Nolte.

Withdrawing from contributions

You can essentially take out contributions from your Roth IRA at any point without incurring taxes or a Roth IRA early withdrawal penalty. If you contribute $1,000 to a Roth today, you can withdraw $1,000 from the Roth tomorrow (although that’s not a sound savings strategy) because you’ve already paid taxes on that money.

Withdrawing from earnings

Earnings in a Roth IRA must be left in the account for at least five years or until the account holder reached the age of 59 and a half — whichever is longer. If you withdraw earnings early, you’ll owe taxes on the money and a 10% penalty.

The five-year waiting period begins on January 1 of the year you made your first contribution. As long as your withdrawal is five years from January 1 of the first year you contributed and you’re at least 59 and a half years of age, you’re in the clear. This rule applies to each Roth you may have.

You may be able to withdraw from earnings without paying taxes and penalties if you’ve had the Roth IRA for at least five years and one of the following applies:

  • The money was used for a first-time home purchase, up to a $10,000 lifetime limit.
  • You are permanently disabled.
  • You died, and your heirs received the money after your death.

You may also be eligible for early withdrawals from your earnings without incurring the 10% penalty, but you’ll still owe income taxes. Early distributions from a Roth IRA that qualify for this rule are as follows:

  • You have reached the age of 59 and a half.
  • You are permanently disabled.
  • You are the beneficiary of a deceased IRA owner.
  • You use the money to buy, build or remodel a first-time home.
  • The distributions are part of a series of substantially equal payments.
  • You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income for the year.
  • You’re paying medical insurance premiums while unemployed.
  • The distributions aren’t more than your qualified higher education expenses.
  • The distribution is due to an IRS levy of the qualified plan.
  • It’s a qualified reservist distribution.

There’s one other exception to this rule: If you withdraw your contributions and earnings from a Roth IRA by the tax deadline for the year in which you made that contribution, the IRS treats your contribution as though it had never happened. However, you must claim any earnings as income for that year on your tax return.

Withdrawing from a Roth conversion

The rules are slightly different if you convert a traditional IRA to a Roth: you must wait at least five years before you withdraw from that IRA. The five-year clock starts on January 1 of the year you made the conversion. You’ll owe income taxes and a 10% penalty for early withdrawals.

Reporting Roth IRA withdrawals

You’ll need to file a Form 8606 when it’s time to file your taxes in the year that you take withdrawals from your Roth IRA. Be sure to inform your tax professional or advisor so they can help you stay on top of your finances.

Bottom line

A Roth IRA is a great way to diversify your retirement savings, particularly if you think you’ll be in a lower tax bracket in retirement. You have limited options if you want to take money out of your Roth before retirement. Be sure to educate yourself on all the rules to prevent getting hit with penalties that will only erode your nest egg.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kate Ashford
Kate Ashford |

Kate Ashford is a writer at MagnifyMoney. You can email Kate at kateashford@magnifymoney.com

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Featured

6 Ways to Find College Scholarships

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

mortar board cash

As the cost of college continues to soar, scholarships have become an essential part of college payment plans. Scholarships covered 17% of the average college bill, according to Sallie Mae’s most recent How America Pays For College report, with an average scholarship haul of $8,843.

Scholarship dollars varied widely, however, based on the type of school attended. Students at a four-year public or state university received, on average, $6,469 in scholarships, compared to $16,527 for students at four-year private universities.

Nonetheless, free money can certainly make a dent in your college tab. And knowing where to look for them is key to the process. Here are a few hints:

1. Search online sites

Scholarship matching websites are still a great source of scholarship information. There’s the U.S. Department of Labor’s scholarship search tool, as well as sites such as Fastweb, The College Board and Cappex. Each site’s search tools are a little bit different, but in general, you’ll be filling out an online questionnaire on everything from your ethnic background to gender to intended major, and seeing what scholarships match your criteria.

2. Skip paid services

“The results will not be better than the free services,” says Mark Kantrowitz, financial aid expert and publisher of Cappex. “The free services update their databases in real time, while paid services license a database that is updated once a year or once a quarter. If you have to pay money to get money, it’s probably a scam.” Kantrowitz recommends searching at least two free sites to give you the confidence that you’ve found all the scholarships for which you’re eligible. However, you can consider certain one-time fee apps like Scholly, which costs $2.99 for a one-time purchase in iOS and Android and helps you aggregate scholarship opportunities.

3. Check the financial aid office

The school you plan to attend may have scholarships available that aren’t listed elsewhere. Give the school a call—either as an incoming student or once you’re attending—and ask for information.

4. Look locally

Your school guidance counselor should know whether there’s any money to be awarded from groups in your area to graduating seniors. Your librarian might also be able to point you toward information on local awards. “Look for small local scholarships on bulletin boards outside your guidance counselor’s office, and near the jobs and careers section of the local public library,” Kantrowitz says. “Also look in the coupon section of the Sunday newspaper, where some national scholarships are advertised.” Groups such as your local Rotary, Kiwanis, and Elks clubs are good places to check, as well as your church.

5. Ask your parents

Do your mother or father work for a company that offers scholarships? If they’re not sure, have them check with their human resources department. Companies such as Verizon, Intel and Siemens offer awards to employee children and dependents, and 11% of employees overall offer this kind of benefit, according to the Society for Human Resource Management’s 2015 Employee Benefits report.

6. Keep applying

Scholarships aren’t just for incoming freshmen. In fact, while freshmen received an average of $5,793 in scholarships, according to Sallie Mae’s most recent numbers, seniors received a whopping $20,292. It pays to keep researching as you work your way through school.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kate Ashford
Kate Ashford |

Kate Ashford is a writer at MagnifyMoney. You can email Kate at kateashford@magnifymoney.com

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College Students and Recent Grads

Tuition Reciprocity Programs to Make College Affordable

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mortar board cash

Candace Ramirez has student loan debt, but it’s thousands of dollars below the national average. That’s because she took advantage of a tuition reciprocity program offered by Western Kentucky University, in which she paid in-state tuition even though she was an out-of-state student from a nearby county in Tennessee. To give you an idea of the savings this creates, the tuition and fees at WKU for the 2015-16 year were $4,741 for in-state residents—and $12,066 for non-residents. “It was a big financial help,” says Ramirez, 24, who now lives in Seattle. “Those tuition programs are a lifesaver.”

The difference in cost between attending an in-state school and an out-of-state school can be staggering. The most recently published average tuition and fees for a public four-year in-state school were $9,410, according to the College Board. For a public four-year out-of-state student, average tuition and fees were $23,893. That’s a difference of more than $57,000 over four years, especially considering that rates generally rise each year.

But if you live in a state without many good in-state options for you, or without schools that offer the degree you’re interested in pursuing, what else are you going to do? As it turns out, in many states you can take advantage of reciprocity agreements with other regions or states that enable you to pay in-state rates—or reduced out-of-state rates—to attend an out-of-state school. You may be able to qualify for this rate for all four years of school, saving you a substantial amount of money.

Here are some of the arrangements that exist, depending on where you live:

The program: Western Undergraduate Exchange (WUE)

What it is: Residents of member states of the Western Interstate Commission for Higher Education (WICHE) can apply to receive a reduced tuition rate no higher than 150% of resident tuition at participating out-of-state college programs.

What savings might look like: An out-of-state resident attending the University of Arizona, for instance, would pay $28,416, versus $9,952 for resident tuition. The WUE rate would be $14,928 (150% of the resident rate), saving that student $13,488 per year.

Participating states: Alaska, Arizona, California, Colorado, Hawaii, Idaho, Montana, Nevada, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington, Wyoming, and the Commonwealth of the Northern Mariana Islands.

The program: Midwest Student Exchange Program (MSEP)

What it is: States that participate in the MSEP agree to a multi-state tuition reciprocity arrangement in which they charge out-of-state students no more than 150% of the in-state resident tuition rate for certain programs. As part of the MSEP, private institutions will reduce rates by 10%.

What savings might look like: The program estimates that students will generally see savings of $500 to $5,000 per year, depending on the institution.

Participating states: Illinois, Indiana, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota and Wisconsin. You must be a legal resident of one of those nine states and enrolled at a participating MSEP school as a non-resident student.

The program: Academic Common Market

What it is: This is a program run by the Southern Regional Education Board (SREB) in which students can get an out-of-state degree at in-state rates at various colleges and universities. Applicants can search the database by state and type of program to see if an agreement exists.

What savings might look like: For instance, a resident of Maryland may be able to pay in-state rates to get a Bachelor’s in biomedical engineering at West Virginia University. At WVU, tuition and fees for a West Virginia resident are $3,816, compared to $10,716 for a non-resident.

Participating states: Alabama, Arkansas, Delaware, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, Oklahoma, South Carolina, Tennessee, Texas, Virginia and West Virginia. Each school has an ACM program coordinator who can help students get more information.

The program: New England Regional Student Program (RSP)

What it is: The New England Board of Higher Education runs this program that offers a discount on out-of-state tuition to New England students who aren’t able to study their desired major at a public college or university in their home state.

What savings might look like: Full-time students saw annual tuition savings of $7,515, on average, according to the program, but you could save more, depending on the school you attend. At the University of Connecticut and University of Maine, out-of-state students could shave more than $13,000 per year off of their bills.

Participating states: Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island and Vermont.

Some states or schools also have their own individual arrangements with neighboring states, such as the University of Minnesota, which offers lower tuition rates to out-of-state residents of North Dakota, South Dakota, Wisconsin and the province of Manitoba, Canada. Call your school’s financial aid office and ask about reciprocity agreements.

Keep in mind: The number of these awards may be limited by institution each academic year, so apply early for consideration.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kate Ashford
Kate Ashford |

Kate Ashford is a writer at MagnifyMoney. You can email Kate at kateashford@magnifymoney.com

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