Author Topic: Withdrawing Roth IRA Principal Early  (Read 8822 times)

berns

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Withdrawing Roth IRA Principal Early
« on: June 13, 2013, 05:41:46 PM »
Anyone have experience with withdrawing Roth IRA contributions that are older than 5 years? If I understand correctly, they are not taxable?

Is it only the contributions that were made 5 or more years ago or any contributions period?

Would the tax paperwork be complicated via something like H&R Block Online or TurboTax or is it just a few questions like, "Does the withdrawal include any gains? How long ago were the contributions made?"

Would appreciate help on any or all questions. I'm considering using them to pay off some 6.8% interest student loans without paying any government taxes/fees.

Thank you!

arebelspy

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Re: Withdrawing Roth IRA Principal Early
« Reply #1 on: June 13, 2013, 06:16:15 PM »
I have done so, it is simple, no tax on any principal withdrawals (not just those 5 years old or more, but any time), get the form from your IRA servicing/holding company.
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jamccain

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Re: Withdrawing Roth IRA Principal Early
« Reply #2 on: June 13, 2013, 11:56:27 PM »
The five year rule is for money you rollover from a traditional IRA into a ROTH. 

If you just make your normal $5K contribution you don't have to wait as arebelspy points out. 

berns

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Re: Withdrawing Roth IRA Principal Early
« Reply #3 on: June 14, 2013, 05:17:07 AM »
Thanks guys, that makes sense. I was starting to get confused reading varying information on the web!

Left

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Re: Withdrawing Roth IRA Principal Early
« Reply #4 on: June 14, 2013, 07:31:48 AM »
how do you figure out which part of the money you are taking out is the principle? Do you specify that you want to take it out of principle? Or is it always principle out first?

madage

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Re: Withdrawing Roth IRA Principal Early
« Reply #5 on: June 14, 2013, 07:46:55 AM »
how do you figure out which part of the money you are taking out is the principle? Do you specify that you want to take it out of principle? Or is it always principle out first?

The "order" of withdrawals is contributions, conversions, then earnings. You can always ask your IRA custodian for help, if you need it.

berns

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Re: Withdrawing Roth IRA Principal Early
« Reply #6 on: June 14, 2013, 08:10:30 AM »
Good to know there's an official order. In my case, I can also look online and it shows me all of my transactions, along with the exact amount of contributions, gains, and fees. If you're not checking your account online, I remember the same kind of information being on paper statements.

jamccain

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Re: Withdrawing Roth IRA Principal Early
« Reply #7 on: June 14, 2013, 12:25:43 PM »
how do you figure out which part of the money you are taking out is the principle? Do you specify that you want to take it out of principle? Or is it always principle out first?

You should have a tax form 548 for each year from your broker. It will state your contributions, but only for the year in question. You can use these to go back and see how much you have put in over the years.

Ryan Dagg

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Re: Withdrawing Roth IRA Principal Early
« Reply #8 on: June 15, 2013, 07:21:59 PM »
how do you figure out which part of the money you are taking out is the principle? Do you specify that you want to take it out of principle? Or is it always principle out first?

The "order" of withdrawals is contributions, conversions, then earnings. You can always ask your IRA custodian for help, if you need it.
This is 100% correct, but many of the other posts are less so. This article does an awesome job explaining: http://online.wsj.com/article/SB125754645803734655.html

The 5 year waiting rule for earnings starts on Jan 1st of the first year you contributed. If you contribute $1 dollar in 1999 and everything else in the past 5 years you still avoid paying income taxes on earnings.

From what I understand of your situations, you can withdraw all contributions tax and penalty free (this is a given for everyone). You can withdraw all earnings tax free, but will pay a 10% early withdrawal penalty if under age 59.5.

That being said, it is generally considered a TERRIBLE idea to pay off your loans with this money, and I completely agree. We are in an interest rate environment that is lower than inflation! If you have an income you should be able to refinance those loans to a lower rate and earn a higher growth rate in your Roth over the long term than this interest. Paying these loans off with extra non-retirement cash is still a good idea.

The idea of someone paying down a reasonable rate loan with an asset that grows tax FREE and has contributions limits makes babies and kittens cry.

I didn't cover conversions because it adds a lot more confusion and while helpful to know the OP didn't mention it.
« Last Edit: June 15, 2013, 07:24:47 PM by Ryan Dagg »

arebelspy

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Re: Withdrawing Roth IRA Principal Early
« Reply #9 on: June 15, 2013, 08:10:02 PM »
If you have an income you should be able to refinance those loans to a lower rate

That's an awfully broad statement to make.  They may have bad credit, for example.

Let's assume perfect credit though, and no desire to get a mortgage (renting, moving soon, and thus no HELOC either).

Where exactly can one get a low interest personal loan merely by showing proof of income?
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Ryan Dagg

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Re: Withdrawing Roth IRA Principal Early
« Reply #10 on: June 16, 2013, 12:50:58 PM »
If you have an income you should be able to refinance those loans to a lower rate

That's an awfully broad statement to make.  They may have bad credit, for example.

Let's assume perfect credit though, and no desire to get a mortgage (renting, moving soon, and thus no HELOC either).

Where exactly can one get a low interest personal loan merely by showing proof of income?
You are correct, this was an overly broad statement. I assumed, without asking, that he was talking student loans through the fed, state or through his university.

As I understand (not an expert on this particular topic) the loan types mentioned above are eligible for consolidation. http://studentaid.ed.gov/repay-loans/consolidation for fed. I have found programs for the other categories as well. I went through this about 2 years ago and am paying 2.25% fixed on my student loans.

Thank you for calling me out arebelspy. Sometimes I get lazy when typing up long-ish posts.

berns

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Re: Withdrawing Roth IRA Principal Early
« Reply #11 on: June 16, 2013, 07:58:47 PM »
I appreciate your guys feedback and would like to come to a rational decision, so let me share the specifics to make this more concrete.

Here are the facts:

- The student loans in question are fed loans of about $15k at 6.8%
- The Roth IRA has about $6,500 in contributions that have earned 5.45% since account opening in 2005
- I have 720+ credit. Not sure if that makes a difference here

I'm hard-pressed to see where I can refinance this unsecured loan at a much lower rate.

Therefore, it seems to make sense to take money earning about 5.5% to pay off 6.8% debt especially since I can replace these contributions once I'm out of debt in just over a year due to the Roth limit.

Note: I would take out only my contributions. I don't want to pay any taxes or fees.

Is there anything I'm missing? Any further comment would be greatly appreciated :-)
« Last Edit: June 16, 2013, 08:00:53 PM by berns »

sheepstache

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Re: Withdrawing Roth IRA Principal Early
« Reply #12 on: June 17, 2013, 12:18:51 AM »
So, taking the $6500 from the IRA would save you, what, about $450 since you'd have it paid off in a year anyway?  A bit less since you'd have been making regular payments on the loan.

Also, you can't "replace" it unless you get it back in by April 15th.  After that, it counts towards your contribution for 2014.

How are you coming up with the 5.45% number?  You didn't contribute all the money in 2005.  So while the total may have increased that much since then, some of it must be going up at a higher rate.

Personally, it seems like too much work for not enough benefit, but I don't know your whole financial picture.  Like, could you cut anything else from your budget?  Also, you didn't ask, but I would look into your investments and investment behavior a bit.  While I agree it's hard to beat 6.8%, there are other factors.  Are you in a high-paying profession now?  Or do you expect to hit income levels past those which allow Roth contributions?  Are you making regular contributions or trying to time the market?  I feel like people who were making regular contributions from 2005 til the present would be doing better than 5.45%


berns

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Re: Withdrawing Roth IRA Principal Early
« Reply #13 on: June 17, 2013, 10:06:38 AM »
More details on the numbers... so this isn't a huge account. It's something I opened at age 18. Contributed regularly part of my small college income. Since then, I've contributed to 401k regularly instead and no, I don't do any timing, just regular contributions.

Contributions: $6,495
Value today: $9,122.90
Total gain: $2,627.90
Total gain (%): 40.46%
Total gain since 2004: 40.46% / 9 years = 4.5% per year

I realize it's not simple to replace withdrawals, especially since the market may go up in the meantime. I also am not sure my income and budget are relevant since it doesn't change the above numbers. Although I am currently saving 50%/month towards debt/investments and am taking steps to increase that, along with the income. However, no I don't expect to hit the Roth income limit within the next year.

At the same time though, if my numbers are correct, I'm interested in exchanging a 4.5% rate of return for a 6.8% rate, unless of course I'm missing something here.

TLV

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Re: Withdrawing Roth IRA Principal Early
« Reply #14 on: June 17, 2013, 10:52:03 AM »
Quote
Total gain since 2004: 40.46% / 9 years = 4.5% per year

That's not an accurate way to calculate your ROI. It doesn't take into account compounding, or that your contributions were made over time.

If you put in all the contributions at once, 9 years ago, then you would calculate the annual rate of return by taking the 9th root, rather than dividing.
1.4046 ^ (1/9) - 1 = 1.038 = 3.8%. This rate is lower because some of the total gain came from compounding.

If you put in the contributions $721 per year over the last 9 years, with the most recent contribution just now, and assume the stock market returned the average amount (instead of being wildly volatile) that whole time, then a bit of spreadsheet estimating puts it around 8.3% - it's much higher, because for most of that time you didn't have as much money in the account.

Since the stock market was volatile, to get the actual number you'd need to take into account the price/#/date of each time you bought shares (including when dividends/distributions were reinvested). This can take some work. Your IRA provider may do it for you if you know where to look - I'm pretty sure both vanguard and fidelity offer that (for fidelity, look under "online statements" and use the custom date range. For vanguard, look under "personal performance.")

berns

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Re: Withdrawing Roth IRA Principal Early
« Reply #15 on: June 17, 2013, 11:27:01 AM »
Quote
That's not an accurate way to calculate your ROI

Thanks for that bit of education. I'm working as a software developer and am forgetting that stuff.

The fund information is actually Washington Mutual Investors Fund (AWSHX) with American Funds.

I found the annualized return information and, to date, it is 7.55% based on my transactions. So, in that case, not making predictions about the future, it would not make sense to use the money to pay off 6.8% rate loans.

So I also see that its expense ratio is 0.62%. Am I overpaying? I see Vanguard funds like

Vanguard Total Stock Market Index Fund Investor Shares (VTSMX)
https://personal.vanguard.com/us/funds/snapshot?FundId=0085&FundIntExt=INT

and

Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX)
<a href="https://personal.vanguard.com/us/funds/snapshot?FundId=0585&FundIntExt=INT">

with much lower expense ratios of 0.17% and 0.05%, respectively, and also higher rates of return of 9.3 - 9.4% over 10 years (about how long I've had the Roth IRA account).
« Last Edit: June 17, 2013, 11:28:59 AM by berns »

arebelspy

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Re: Withdrawing Roth IRA Principal Early
« Reply #16 on: June 17, 2013, 11:39:42 AM »
Quote
That's not an accurate way to calculate your ROI

Thanks for that bit of education. I'm working as a software developer and am forgetting that stuff.

The fund information is actually Washington Mutual Investors Fund (AWSHX) with American Funds.

I found the annualized return information and, to date, it is 7.55% based on my transactions. So, in that case, not making predictions about the future, it would not make sense to use the money to pay off 6.8% rate loans.

So I also see that its expense ratio is 0.62%. Am I overpaying? I see Vanguard funds like

Vanguard Total Stock Market Index Fund Investor Shares (VTSMX)
https://personal.vanguard.com/us/funds/snapshot?FundId=0085&FundIntExt=INT

and

Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX)
<a href="https://personal.vanguard.com/us/funds/snapshot?FundId=0585&FundIntExt=INT">

with much lower expense ratios of 0.17% and 0.05%, respectively, and also higher rates of return of 9.3 - 9.4% over 10 years (about how long I've had the Roth IRA account).

I have an answer of what I would do if it were me, but I think a yes/no is less helpful to you than the following.

LTR's latest post (the first reader question here) may help you noodle through your own situation and decide for yourself if you should move the funds or not: http://www.longtermreturns.com/2013/06/alliance-bernstein-or-vanguard.html

There are many factors including return, expense ratio, taxes (if in a taxable account), etc.

Read his reply, then apply to your own situation.

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Ryan Dagg

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Re: Withdrawing Roth IRA Principal Early
« Reply #17 on: June 18, 2013, 01:51:54 PM »
I'm hard-pressed to see where I can refinance this unsecured loan at a much lower rate.
I just spent a fair amount of time trying to find resources to help with this and learned that I was way off base. It appears that I got very lucky with the way that my fed loans were structured and consolidation for someone in your situation could be only marginally beneficial if your rate is variable.

The only interesting thing that I did find was this: https://www.sofi.com/
They have a new business model and I have done no due diligence on them. Also, I have no idea if you attended one of the covered schools.

The other big idea that has been mentioned by others is using home equity. I personally think this would be favorable over cashing out your Roth, but can be a lot more complicated.

Wish I had more.

arebelspy

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Re: Withdrawing Roth IRA Principal Early
« Reply #18 on: June 18, 2013, 02:00:31 PM »
The only interesting thing that I did find was this: https://www.sofi.com/
They have a new business model and I have done no due diligence on them. Also, I have no idea if you attended one of the covered schools.

I actually know someone that may be perfect for. Thanks for sharing!
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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