Roth IRA investors can start withdrawing

But is it wise to do so?

Are you one of the early adopters — someone who opened a Roth IRA when they were first offered in 1998?

Time then for a brush-up on the rules, since people who opened Roths in 1998 and 1999 can now take money out without paying the 10 percent penalty that investors associate with IRA withdrawals before age 59 1/2.

Of course, you probably shouldn’t take money out, but I’ll get to that later.

The rules permit penalty-free withdrawals once the account has been open for five years. They assume the account was opened on Jan. 1, even if it wasn’t set up until later in the year.

Even if you are subject to the 10 percent penalty, it generally applies only to investment gains that are taken out, not your original contribution.

Accounts opened during 1998 hit the five-year mark on Jan. 1, 2003. Accounts opened in 1999 hit the five-year mark Jan. 1, 2004.

Before you rush to the phone to drain your Roth, note that there’s a catch. Unless you are 59 1/2, any investment gains you withdraw will be taxed at income-tax rates. The principal — the money you invested — can be withdrawn without tax or penalty.

Common questions

Can you withdraw just the principal? Yes. If you don’t withdraw everything in the account, it will be assumed that you initially withdraw principal, and that you don’t start taking out investment gains until you’ve withdrawn all your principal.

What if you have more than one Roth? Then you can withdraw, tax-free, an amount equal to the combined principal of all the accounts. It doesn’t matter which account it comes from.

Does the date of your birthday matter? To be considered 59 1/2, you must hit that age no later than Dec. 31. So you could make a tax- and penalty-free withdrawal today, even if you won’t turn 59 1/2 until the end of the year.

Must you limit your withdrawal to funds that have been in the account for at least five years? No. So long as your Roth — or one of your Roths — is 5 years old, you can take out money that was contributed more recently.

Same goes for investment gains: You could get penalty-free treatment of investment gains made yesterday and withdrawn today, so long as you have an account that was opened no later than Dec. 31, 1999.

What if you have more than one Roth account? You need meet the five-year requirement on only one of them. Once that’s done, you can make penalty-free withdrawals from any of them.

Anything else? Yes. If you’ve had a Roth for five years and are not yet 59 1/2, you can make a penalty- and tax-free withdrawal of up to $10,000 to buy a home for yourself, a child or grandchild. The buyer and his or her spouse must not have owned a home during the previous two years.

Don’t withdraw

Now to the bigger issue — should you make a withdrawal before turning 59 1/2

Only if you’re desperate and have no alternative.

Though you may be able to escape the 10 percent penalty, taxes on pre-59 1/2 withdrawals can be high. Income tax rates go from 10 percent to 35 percent, with most investors paying 25 percent to 33 percent.

It would be a shame to pay a lot of tax if you could postpone the withdrawal and pay none. That’s the big appeal of Roths — tax-free treatment of investment gains once you’re 59 1/2.

Even if you will be that age by the end of this year, the best practice would be to postpone withdrawals as long as possible. That way, you get more years of tax-free compounding.

Ideally, a new retiree will live primarily on pension and Social Security, making up any shortfalls by taking money out of ordinary taxable accounts. That allows tax-favored accounts such as IRAs and 401(k)s to keep growing.

In fact, many people are drawn to Roths because they won’t ever have to make withdrawals, allowing investors to enjoy more compounding or leave more to their heirs. With traditional IRAs, investors are required to withdraw minimum amounts once they’ve turned 70 1/2. Roths don’t have that rule.