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.