Although dubbed a penalty, does a Roth-IRA early withdrawal "penalty" effectively lower the short term capital gains rate to 10% instead of linked to your actual income bracket?

As the early withdrawal is levied only the amount withdrawn, it doesn't matter how long a position was opened inside the IRA, long term investment gains, short term investment gains, anything, is taxed at 10% on withdrawal.

Is my understanding correct?

Any other non-retirement account I would fund would also be with post-taxed money. Opening a Roth-IRA with any of those funds (although limited to a maximum contribution per year) and gaining more from the exact same investment strategies effectively lowers the capital gains tax rate from 28%, 35% whatever all the way down to 10%, and even then only on the year that the withdrawal occurs


1 Answer 1


You can take out the contributions to your Roth tax and penalty free. That's the good thing.

Anything above the amount you contributed that you withdraw early will cost you ordinary income tax (which is higher than capital gains tax) plus a 10 percent penalty on that amount. So if you have $15,000 in the account and $5,000 is gains and you withdraw $11,000, then you owe tax and penalty on $1,000. The penalty is 10% and your taxes (high taxes!) are added to that. Pretty bad deal.

If you kept it in a normal account and paid capital gains tax, you just pay 15% (or whatever) on your gains and you get to offset income tax with your losses via tax loss harvesting.

So back to your question: your idea works even better than you suggested if you only withdraw up to the amount that you contributed (you pay no tax!). Take out any of the gains and you will be penalized more than you would if you just paid capital gains on them. Leave those in until you are old enough to take them out penalty and tax free.

To me, contributing to a Roth, making a bunch of gains on it, and withdrawing only the contribution part whenever you want seems to make good sense.

  • Insightful, you still get to ignore capital gains tax until the year you withdraw, its just ok then
    – CQM
    Apr 24, 2016 at 5:03
  • @CQM No, IRAs are not investments, and the taxable portion of any withdrawal (whether from Traditional or Roth IRA) is subject to income tax at your marginal tax rate for ordinary income, and not your capital gains tax rate. Nor is this taxable portion subject to the recently introduced 3.9% Medicare tax for large investment incomes because withdrawals from IRAs are not investment income. Apr 24, 2016 at 13:52
  • @DilipSarwate the short term capital gains rate is the same as income's marginal tax rate. The contents of iras can be invested in the same things as other investment accounts, so that justifies the comparisons. I get that they are different: legislatively. This scenario is specifically about using a roth ira account as a tool that profits from inefficiencies in legislation. It looks like you can create a scenario where the penalty is still better because you didn't pay tax on gains in at least one tax year allowing more capital to stay in the account (let alone worrying about wash sale rules)
    – CQM
    Apr 24, 2016 at 19:33
  • @CQM I don't understand your last comment. If you take all your money out of the Roth, paying the penalty and tax on all your gains, to me it seems unlikely that you can beat leaving it outside the Roth. The only way you win that I see is if you only withdraw your contribution early and take the growth after 59.5.
    – farnsy
    Apr 25, 2016 at 15:51
  • If you exited an investment within one year of taking it (at a profit), and entered a new investment that also gained, in a Roth IRA you don't have to pay tax on that short term gain. Outside of a Roth IRA you would have had to pay tax on that gain that year, leaving you with less investable funds assuming you withdrew from that account to pay the tax. Inside a Roth IRA gains every year from positions that lasted less than a year get to go untaxed that year allowing the account to grow faster. cont.
    – CQM
    Apr 25, 2016 at 17:53

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .