Executive Summary
While Roth IRAs are very popular as a retirement savings vehicle due to their tax-free growth treatment, they also have several unique rules associated with them to ensure that their favorable tax status is not abused. In particular, there are two different 5-year rules associated with Roth accounts to prevent them from being taken advantage of; the first 5-year rule applies to Roth contributions and determines whether earnings will be tax-free, while the second 5-year rule applies to Roth conversions and determines whether conversion principal will be penalty-free.
Each of the 5-year rules are measured from the beginning of the tax year for which they apply, which means in reality tax-free earnings or penalty-free conversion principal may be accessible in less than 5 years in certain circumstances. And because the Roth rules aggregate all accounts together for the purposes of determining the tax treatment of various distributions, it's necessary to track the various 5-year rules and the amounts they're associated with, regardless of whether they are held separately or mingled together into a single account.
Ultimately, being able to effectively navigate the various Roth 5-year rules creates several planning opportunities as well. For some, taking advantage of the Roth conversion 5-year rule is a way for those well under age 59 1/2 to tap their IRA funds "early" without an early withdrawal penalty. For others, the reality is that the Roth conversion 5-year rule is a moot point anyway, because they already meet another exception to the early withdrawal penalty (e.g., already being over age 59 1/2). However, in all cases, the 5-year rule for contributions must be met before any Roth earnings can actually be tapped tax-free; fortunately, though, because any first-time contribution or conversion can start the clock, clients who are concerned about the 5-year rule can make a contribution to a Roth (or to a traditional IRA and then convert it) to start the time window now, and ensure they'll never need to worry about it in the future!
5-Year Rule For Roth Contributions
The 5-year rule for Roth contributions is used to determine whether a withdrawal of growth will be tax-free as a "qualified distribution" from a Roth IRA (which is not automatic, just because growth is tax-deferred along the way).
In order to be a tax-free qualified distribution from a Roth IRA, two requirements must be satisfied. First, under IRC Section 408A(d)(2)(A), the distribution must be made either: on/after the date the IRA owner turns 59 1/2; after death of the IRA owner (i.e., to the estate or a beneficiary); after becoming totally disabled (under the Social Security definition of "total disability"); or for qualified first-time homebuyer expenses (up to a $10,000 limit and subject to other limitations). The second requirement, in addition to meeting one of the preceding tests, is that the distribution must meet the Roth contribution 5-year rule (also known as the "nonexclusion period" under IRC Section 408A(d)(2)(B)).
The 5-year rule essentially states that five tax years must pass from when the first contribution is made to (any) Roth IRA, until a qualified distribution can be made. Because the measurement is based on tax years, this means that a contribution (not just a rollover, but an actual new contribution) to a Roth IRA as late as April 15 of 2014 will still count as a contribution for the 2013 tax year (in essence, it counts as though the contribution was made January 1st of 2013), which means the first year of a potential qualified distribution would be 2018 (because the five years that passed would have been 2013, 2014, 2015, 2016, and 2017). Notably, this means that a "5-year" qualified distribution could actually be made after less than 3 years and 8 months, as a contribution on April 14 of 2014 (made in 2014 but for 2013) would allow for tax-free distributions as early as January 1st of 2018.
Notably, under Treasury Regulation 1.408A-6, Q&A-2, for the purposes of this 5-year rule the clock starts the first time any money is funded into any Roth IRA, whether by contribution or conversion. There is not a new 5-year clock for each Roth contribution, nor for each Roth account that is held. All Roth IRAs (but not Roth 401(k)s) are aggregated together to determine whether the 5-year rule is met for any/all of them (which indirectly means that rollovers from one Roth IRA to another do not change or reset the 5-year requirement). In the case of rollovers from a Roth 401(k), any years in the Roth 401(k) are not added to the years for the Roth IRA; thus, if the individual did not otherwise have a Roth IRA already, the rollover from a Roth 401(k) begins a new 5-year period, even if the Roth 401(k) itself had already satisfied the 5-year requirement (per Treasury Regulation 1.408A-10, Q&A-4(a)).
The fact that the 5-year requirements are aggregated across IRAs effectively means that once the 5-year rule has been satisfied once for a taxpayer (i.e., if you've already had a Roth for at least 5 tax years), it's been satisfied for good; in turn, this means that recent contributions may actually be eligible for withdrawal as a qualified distribution even if they've been in the account for less than 5 years, as long as the taxpayer overall has met the 5-year requirement with respect to any Roth IRA.
Bear in mind, though, that regardless of whether the 5-year rule is met, for the distribution to be qualified, it must still also satisfy the first part of the test (a distribution made after 59 1/2, death, disability, or under the first-time homebuyer rules).
5-Year Rule For Designated Roth Accounts Under A 401(k) Or Other Employer Retirement Plan
In the case of a Designated Roth Account under a 401(k) or other employer retirement plan, the 5-year rule again applies to determine eligibility for a qualified distribution. However, under Treasury Regulation 1.402A-1, Q&A-4(b), the 5-year rule for an employer retirement plan is counted separately from the 5-year rule for any/all Roth IRAs. Thus, even if the 5-year rule has already been satisfied for qualified distributions from a Roth IRA, a Roth 401(k) still has to satisfy its own 5-year period.
In addition, each employer plan is subject to its own 5-year rule, in the event that someone has multiple Roth accounts under multiple employer retirement plans. Although if one Roth employer retirement plan is directly rolled into another - e.g., if the balance of one Roth 401(k) is rolled into another Roth 401(k) - then again under Treasury Regulation 1.402A-1, Q&A-4, the 5-year period is based on whichever plan has been around longer (the original plan or the new one being rolled in to). Thus, once a designated Roth account under an employer retirement plan has satisfied the 5-year rule, it can continue to be satisfied with a new designated Roth account as long as the 'old' funds are rolled into the new plan. And if a "new" plan has already satisfied the rule, any old Roth employer plans rolled in will have already satisfied the rule as well.
On the other hand, when a designated Roth account from an employer retirement plan is rolled into a Roth IRA, the years in the Roth employer plan do not count towards the Roth IRA. Instead, under Treasury Regulation 1.408A-10, Q&A-4(a), for a Roth IRA it's the original 5-year rule for the Roth IRA that counts. And if there was no existing Roth IRA and the rollover from the Roth 401(k) creates the account for the first time, that starts a new 5-year clock for the IRA, even if the 'old' Roth 401(k) had satisfied its own 5-year rule. Again, any years in the Roth 401(k) (or other Roth employer retirement plan) do not carry over and get tacked onto the Roth IRA.
The Second 5-Year Rule, For Roth Conversions
As the name implies, the second 5-year rule applies not to (new) Roth contributions, but to Roth conversions from traditional pre-tax retirement accounts, and determines whether Roth conversion principal will be penalty-free.
To meet the 5-year rule for Roth conversions, again the measuring period is five tax years, which essentially means any Roth conversion is deemed to have occurred as of January 1st of that year (Treasury Regulation 1.408A-6, Q&A-5(b)). Notably, since conversions must occur by December 31st in a given year, their 5-year period will always start in the calendar year in which the conversion occurs; for instance, any conversion between January 1st and December 31st of 2013 will count as a 2013 conversion, but anything in 2014 will count as a 2014 conversion (by contrast, a new contribution as late as April 15th of 2014 could still be counted towards the 2013 tax year).
Unlike the 5-year rule for contributions, in the case of conversions, each conversion amount has its own 5-year time period (Treasury Regulation 1.408A-6, Q&A-5(c)), and thus with multiple conversions there may be multiple different 5-year periods underway at once. When withdrawals occur from conversion amounts, they are deemed to be withdrawal on a first-in, first-out basis under IRC Section 408A(d)(4)(B)(ii)(II), which effectively means the oldest conversions (most likely to have finished their 5-year requirement) are withdrawn first, and the most recent conversions are withdrawn last. (Overall, the ordering rules from Roth IRAs stipulate that withdrawals are after-tax contributions first, conversions second, and earnings third.)
Intention Of The 5-Year Rules
The purpose of the 5-year rule on Roth contributions is relatively straightforward - to require that tax-free growth for retirement purposes be done for the long-term, which means the account must be maintained for at least 5 years (in addition to meeting one of the other requirements).
To understand the purpose of the 5-year rule for Roth conversions, an example of what would occur if it wasn't there might help.
Example 1. Jeremy is 40 years old and would like to tap the $50,000 of funds in his traditional IRA. If he takes a withdrawal now, he will be subject to ordinary income, and a 10% early withdrawal penalty. If Jeremy converts his IRA to a Roth IRA, he will also be required to report the amount as ordinary income; however, he can now take a withdrawal of his "after-tax" principal from his Roth IRA (the conversion amount) without an early withdrawal penalty. The end result: Jeremy could entirely circumvent the IRA early withdrawal penalty by simply doing a Roth conversion first and taking the money thereafter, so the 5-year conversion rule is designed to prevent this!
Example 2. Continuing the prior example, if Jeremy completes his conversion and waits 5 years, he will be eligible to withdraw his Roth conversion principal without any early withdrawal penalty; this is true because he has met the 5-year requirement for conversions, even though he would only be age 45 at the time. Thus, while the 5-year conversion rule prevents individuals from outright dodging the early withdrawal penalty from their IRAs, it does allow them to potentially gain access to their IRAs prior to age 59 1/2, albeit with a 5-year waiting period! (Though notably, any gains on Jeremy's conversion would still be taxable, as even if he has met the 5-year requirement for conversions and contributions, he has not met the 59 1/2, deceased, or disabled requirement to receive tax-free qualified distributions from his Roth IRA.)
Accordingly, it's also worth noting that because the 5-year rule for Roth conversions merely leaves the withdrawal of conversion principal potentially subject to the early withdrawal penalty, any other exceptions to the early withdrawal penalty can still shelter the Roth conversion amount from the penalty. Thus, withdrawals within 5 years of conversion by someone who is already over age 59 1/2 are not subject to the early withdrawal penalty, regardless of the 5-year conversion rule, simply because being over age 59 1/2 itself is an exception to the penalty!
Roth Strategies To Manage The 5-Year Rules
Because of the different purposes of the 5-year rules, effective techniques for managing and planning around them are different as well.
In the case of the 5-year rule on Roth contributions, the easiest way to manage the rule is simply to start the clock as early as possible, since any first amounts placed into a Roth IRA start the clock. For many, they have already started (or entirely satisfied) their 5-year requirement with prior Roth contributions. For those who have never chosen to make a Roth contribution - or perhaps couldn't, due to the income limitations - an alternative is to do a conversion from a traditional IRA to start the clock; even just a modest $100 conversion is enough to open the time window. For those who have no IRA funds to convert, they can even create an IRA just for the purposes of doing a conversion, as there are no income limits on traditional IRA contributions (the income limits only determine whether the contribution will be deductible or not). However, those looking to do a (nondeductible) traditional IRA contribution and subsequent Roth conversion may wish to wait a year to avoid the risk of the step transaction doctrine.
In addition, it's notable that because distributions are deemed to come from principal first and earnings second, even withdrawals from a Roth contribution within the 5-year time window will not necessarily trigger any income taxation, unless the total distributions exceed all prior contributions. However, it's also important to bear in mind that even if the withdrawal is principal and not subject to ordinary income taxation, if it is a conversion amount within the 5-year time window, the withdrawal may be subject to early withdrawal penalties even if it is not otherwise taxable. On the other hand, as noted earlier, if the individual is otherwise exempt from the early withdrawal penalty (e.g., by being over age 59 1/2), the withdrawal of conversion principal is penalty-free (over 59 1/2) and tax-free (as it was already taxed at conversion). Thus, for those who are already over age 59 1/2 (or totally disabled), the Roth conversion 5-year rule is essentially a moot point, and only the 5-year rule for contributions remains relevant.
Another notable situation where the rules may overlap is after the death of a Roth IRA owner. As death is an exception to the early withdrawal penalty, any beneficiaries taking distributions from a Roth IRA will always enjoy penalty-free treatment (regardless of whether it's principal or earnings, and regardless of whether the 5-year rule for conversions has been met or not). On the other hand, death does not eliminate the 5-year contribution rule for earnings to be tax-free! Thus, beneficiaries taking withdrawals from a recently opened Roth IRA (if there were no other Roth accounts to start the 5-year clock) may find that the earnings are still taxable until the 5-year time window has passed from when the original Roth owner established the account; on the other hand, because of the favorable ordering rules, beneficiaries taking RMDs will be tapping tax-free and penalty-free principal anyway, so this issue would generally only apply if the beneficiaries were liquidating most/all of the Roth IRA shortly after inheriting it (and before the original 5-year contribution time window had been satisfied).
For convenience purposes, because the Roth rules aggregate together all Roth accounts under IRC Section 408A(d)(4)(A), there is no need to keep Roth contributions and conversions in separate accounts, or to otherwise try to separate out multiple types of contributions. The aforementioned ordering rules (principal first, then conversions on a FIFO basis, then earnings) apply in the aggregate across all accounts. So at the most, accounts should only be kept separate if it is necessary/helpful for tracking and accounting (though notably, conversions should be kept separate if there is an expectation they might be recharacterized and there is a desire to just recharacterize the specific gains/losses and assets associated with that particular conversion).
The bottom line, though, is simply this: it's important to remember that there are two separate 5-year rules, each with their own requirements and stipulations. The Roth conversion 5-year rule is about accessing penalty-free conversion principal (and is irrelevant if the individual already meets one of the other exceptions to the early withdrawal penalty), while the Roth contribution 5-year rule is about accessing tax-free Roth earnings (which are assumed to be extracted last, anyway).
Karl frank says
Thanks, Michael, for a great conversation and a very interesting planning point with your 40 year old client. I’ve run into issues with the aggregation rules before and there are a lot of mistakes made by well-intentioned people. An important planning point, 401k money, Roth or otherwise, is excluded from aggregation rules. For example, a self-employed person transfers IRAs into 401ks (Roth or otherwise) and leaves out an IRA with after-tax basis. Then converts the basis IRA to a Roth and benefits from a much smaller “aggregation.” Good stuff!
Carol says
This is a great article. It adds vivid clarity to the distinctions and thinking underlying the two five year rules, which are not clear from reading government publications such as Pub 590. Since Roth classification can be achieved now in so many ways — directly through contributions, via conversions from traditional IRAs and from 401k rollovers — this type of clarity is all the more important to planners and clients. I state this need in coincidence as I just had yesterday a conversation with a colleague who was talking about ‘the five year rule’, lumping together the contribution and penalty together in error. Thanks again.
Neal says
Michael this is by far the most thorough site I have found regarding the flexibility of Roth IRA & Roth 401k. I just am looking for one final clarification. I recently left an employer where I contributed approximately $5000 to a Roth 401k, and it has approximately $500 in earnings in addition. If I roll that to my Roth IRA that is 12 years old the $5000 would come over as contributions and the $500 as earnings correct? If I withdraw 7 days later the $5000 in addition to the $10,000 of existing contribution basis in the Roth IRA it would all come out tax-free and penaly-free because I satisfied the 5 year rule with the Roth IRA?
WDS says
Excellent, informative article. I have a simple (naive) followup question: Regarding the 5-year conversion rule, does the 5-year clock restart if a Roth IRA is rolled over from one account at a given institution/company to another account at a different instition/company? e.g., if I had a Roth IRA with Bank of America for 3 years, but rolled that over to a Roth IRA at another investment firm where it remained for another 3 years, is the clock not at 6 years, or only 3 years because I moved the funds?
Michael Kitces says
WDS,
The 5-year clock for Roth IRA earnings to be tax-free is a per TAXPAYER rule, not per account or institution. So it doesn’t matter than you roll the Roth IRA from one institution to another, the 5-year rule transcends the change in IRA custodians.
Or in your specific example, 3 years of the Roth IRA at Bank of America and another 3 years of the Roth IRA at another investment firm is indeed 6 years. 🙂
– Michael
Does it make any difference if you are going from your employer’s Roth 401K to your own self directed Roth IRA ?
Great article. I am 62 and opened a new Roth IRA in 2012 and funded it with a rollover from a Roth IRA opened in 2009. Because of your article, I know this meets the 5 yr rule. But, I also had a Roth 401(K) funded in the past 2 years and recently rolled it into the 2012 Roth IRA.
If I take a 100% distribution in 2015 from the 2012 Roth IRA will the distribution be tax free?
Excellent. You are one of the few “experts” who have been able to fully explain all the rules for Roth withdrawals, at all ages. It’s amazing how poorly many highly qualified people and financial websites fail to explain ALL the aspects of Roth contributions and withdrawals. It’s like to them, only some of the rules matter to most people, so they can skip the rest. You don’t do that, which is why you deserve credit. And I have to admit, even though I’m a boomer, I think the younger generations are a lot more logical in how they explain financial rules, including the tricky 5 year conversion rule after you turn 59 1/2, and why it’s not applicable.
This is by far the best, most comprehensive summary on Roth IRAs that I’ve come across. Thanks for putting this together.
Thanks Matt, hope it helps! 🙂
– Michael
Is there anyway to find out exactly what your Roth Contributions are??? When I started working back in 2006 i contributed regularly to a roth IRA and made a couple of conversions also… then in 2014 I moved my Roth IRA to vanguard… now in 2021, I don’t have any records of what I contributed before moving account to vanguard… I’ve tried contracting merrylynch, but they no longer have records of my account… I tried calling the IRS help line and they said that they didn’t keep track of that information either… So how in the world can i figure this info out? Please help! Thanks! Very good article!
I have an interesting scenario. One spouse has a Roth IRA. When that spouse dies, ownership of the Roth IRA is claimed by the surviving spouse under the rule for surviving spouses.
What happened to the 5 year clock in this situation? Does the surviving spouse start a new 5 year clock, or does the original clock apply? Then if the surviving spouse dies, when does the 5 year clock start for the heir.
Steve…
No new rollover it’s your to get. Point blank you are the ownership of it. It’s like a death policy and you are the beneficiary its your to get.
Inherited IRAs can have a 5-year waiting period as well, but it starts with the original account owner. If the account owner dies before 5 years have elapsed, the clock keeps going when the inheritor gets it.
Read more: http://www.bankrate.com/finance/retirement/roth-ira-5-year-rule.aspx#ixzz4GOUO2d6Q
Hh
Many thanks, Michael for putting this together! Comprehensive and detailed. I just turned 59.5 and have had a Roth IRA for at least 10 years. So, I’ve satisfied the 5-year rule. Now, can I keep contributing to my Roth IRA every year forward (within the annual contribution limits) and letting it grow, while also withdrawing part or all of it at any time from this point forward tax free? It seems like that is too good of a deal to pass up if I can do that!
Hi Michael. Thanks for the clear explanation of this topic. Could you describe which Federal tax forms come into play when executing the 5 year conversion rule? I converted money from a Traditional IRA to a Roth IRA back in 2010 and am planning on withdrawing the principal from the Roth IRA early next year. How should I have declared the conversion in 2010 (want to make sure I did it correctly) and then how do I declare the penalty-free withdrawal on the 2015 Federal tax form?
Thanks!
James
Agle manth
There is no form that keeps track of the number of years of conversion
basis – only the total conversion basis, in form 8606. There is form
5329 where the amount of distribution subject to the penalty is entered. I once made a mistake and had to account for $40 of such distribution, paying a penalty of $4, LOL.
Great article! if you roll over a 401K (say 100K) to a roth ira (and paying the tax) but later pull out the 401K contribution (not earnings) to make a down payment on a first time home purchase do you pay a penalty or new taxes on this ab=mount because it breaks the 5 year rule?
I know roth ira contributions aren’t taxed if you withdraw them since its post tax money, but does that apply to conversion contributions if pulled out prior to 5 years?
thx
Think what it means is the the actual contribution amount can be withdrawn anytime with no tax. It’s the earnings on the contribution you pay tax on
I need some clarification. If I roll over a Roth 401k to a Roth IRA for the purposes of taking a distribution for the first time home buyer benefit of avoiding the 10% penalty, with less than the 5 year waiting period I have to pay full taxes on the entire amount? If I had just taken the distribution from the Roth 401k and only taken the 10% penalty and no taxes Id be ahead of the game.
I guess no one ever replied to you and this is the question that I need answered. I can’t see to find it anywhere. I am first time home buyer. I recently rolled over my 401K from an old employer to a roth IRA. Now I would like to withdraw for purchasing a home. However, it is still not clear to me if because it was previously in a 401K for more than 5 years if that qualifies..?
Roth contributions that were originally contributed to a Roth (not from a conversion, just from a contribution) are ALWAYS available tax-free and penalty free. That’s true whether the funds were contributed directly to the Roth IRA, or were contributed to a Roth 401(k) and then rolled over to a Roth IRA. There’s no penalty associated with the principal, so the first-time homebuyer exception is moot.
In the case of withdrawing EARNINGS from a Roth (i.e., you got all of the contributions, and still want more) you DO need to satisfy the EARNINGS 5-year rule. That 5-year rule from a Roth IRA is measured JUST for when you had a Roth IRA, and the Roth 401(k) time does not tack on.
In other words, you put $5,000 into a Roth 401(k). It sits there for 7 years. You move the now-up-to-$7,000 to a Roth IRA (which is your first Roth IRA ever). The first $5,000 is tax-free and penalty-free. The last $2,000 will still be taxable (failed the tax-free earnings test because not 5 years in the new account) though there will be no early withdrawal penalty. However, if you had ALREADY had another Roth IRA (that was more than 5 years old) and rolled the Roth 401(k) into it, you’d have already met the 5-year test for tax-free earnings so the first-time homebuyer exception would work for the earnings.
I hope that helps!
– Michael
I would like to explore a question in regard to the “growth” of a Roth. I contributed $5000 3 yrs ago to my Roth IRA, and through a series of poor investment choices, now have value of $2500. If I were to withdrawal those funds now, would I be penalized? I have not met a five year requirement, but I also have no growth. Could you please explain how this will be treated?
Joshua S.
Joshua,
Withdrawals of original contributions to a Roth are always tax-free and penalty free, and withdrawals are always assumed to come from contributions first (and growth second).
So your withdrawals would simply be a tax-free and penalty-free return of your principal. That’s it.
Bear in mind, though, that once you withdraw, contributing again will be subject to the annual contribution limits, so money you take out can’t always easily be put back in, especially if you’re already making ongoing contributions as well.
To the extent you close out the ENTIRE Roth so there is NOTHING left, you can claim a loss on the Roth. But it is a miscellaneous itemized deduction subject to the 2% of AGI floor, and adjusted out entirely for AMT purposes, so there may not be much value to doing so.
I hope that helps a little!
– Michael
If you converted 10,000 into 2 roth iras in 2003, can you take out 15,000 of one of them prior to age 591/2 without penalties? In other words can you aggregate the total of converted roths and take a distribution from one that exceeds the amount that was converted in that one?kpd645
I own a Roth IRA account and I invest in a Roth 401K with my existing employer. I don’t think employers typically allow withdrawals from Roth 401K (or any 401K) until you leave employment. (unless you want to borrow and return it). Withdrawals from Roth IRAs from the contributions only are not taxed or penalized. My question is: If a person over several years has contributed $5000 to a Roth IRA and $5000 to a Roth 401K, can the person withdraw $10,000 from the Roth IRA, and from IRS perspective, it is considered tax free and penalty free since your combined contribution to both Roth accounts was $10,000? This is an attempt to work around the employer restriction of withdrawing from the Roth 401K account.
I have a question on taxes for earnings related to 5 year rule for conversion. I am over 59 1/2 and have roth accounts funded by contributions started long before 5 years ago and they have earnings. I believe I could withdraw all of the roth without taxes from this roth. If I do a $10,000 conversion in 2014 and in 2015 the earnings on that roth conversion are $100 and I withdraw all of my roth accounts both contributions and conversions. I understand that all of my contributions are tax free.
My question is will I be subject to tax on all of my roth earnings including the earnings on my roth contributions or will I be subject to tax only on the $100 earnings from the conversion which did not meet the 5 year rule?
John,
If you are over age 59 1/2 and have your Roth accounts funded more than 5 years, your earnings will not be subject to tax. Period. It doesn’t matter the source, the time horizon, or anything else at this point. You’ve met the requirements for tax-free earnings from a Roth, and that’s that. You could convert a million dollars today and take out the growth tomorrow, you’ve already met the age 59 1/2 and 5-year requirements for tax-free earnings from a Roth.
– Michael
Michael:
I stumbled upon your article as I have seen different interpretation of the 5-year rule for Roth distribution. Thank you so much for this article, and for this additional response to this question. I am in exactly the same boat: started contributing to ROTH over 20 years ago, and then started to convert my rollover IRA to ROTH after retirement at 62. Given that I met both the 59 1/2 and 5-year requirements for tax-free earnings from a Roth, these 2 criteria effectively cancel the 10% penalty on the 5-year conversion waiting rule? So I don’t even need to keep track of the conversion at all?
Again, thanks very much for a very comprehensive article which obviously is timeless…
Kim
If I have an existing Roth IRA over 5 yrs old then if I roll over a Roth 401k, the 5 yr rule is met, but if I convert a traditional IRA or 401k to Roth IRA, the 5 yr clock will start with each conversion, even if rolled over into the existing Roth IRA?
Michael,
I am 60 years old and am planning to convert my balance in my company’s 401k plan over to a Roth 401k account within the company plan this year. I will be taxed on that conversion this year-2014. If I pull the funds out before 2019 (5 year rule), will I be taxed on the withdrawal? If I am, what happens to the taxes I paid on the conversion?
Michael what a great article and explained very well with the two 5 year rules. I had a question
that I can’t seem to find an answer anywhere. For the past 10 years or so I have been consistently converting 10,000 a year from an IRA to a Roth. After my first 5 year waiting period I have always have at least 10,000 I could take out penalty free for whatever every year. In some years I didn’t take out the full 10,000 but generally most of it. For 2014 I have available 20,000, 10,000 from 5 years previous (year 2009) and another 10,000 from years accumulated prior to 2009 where I didn’t take out my maximum 10,000 available.
Now in 2014 I also have qualified educational expenses for my son of 15,000 which I withdrew an offsetting 15,000 from my Roth IRA. In addition I also took out 10,000 for myself assuming I would have 20,000 to work with penalty free not including the 15,000. My tax program is showing me that the 15,000 for education is going against the 20,000 available thus making 5,000 subject to a 10% penalty. (15,000 + 10,000 = 25,000 -20,000 = 5,000) This doesn’t
seem correct to me as everything I read shows qualified educational expenses are not subject to the 5 year rule. I also understand there is a FIFO rule so I’m not sure which rule you would apply first. I have read where the first time home purchase, disability and other reasons seem to be called qualified but education is called an exception. Seems the qualified may be treated different than the exceptions, but is very unclear on what I have read.
I can negate the 5,000 penalty by making a 5,000 contribution prior to April 15 15 for the 2014 tax, but would prefer to avoid if possible. (contributions first then conversions) I just want to double check as it doesn’t seem correct. I was thinking if someone only made a conversion in 2013 that money could be taken out in 2014 for qualified education, so it doesn’t follow to me that the FIFO rule should be applied for Education. Could be a nuance of the Roth, who knows thanks
This is helpful but I have one other question for the case of a non-spouse beneficiary younger than 59 who inherits an IRA that had been converted to a Roth less than five years earlier. Is the taxable portion all of the earnings since the original (non-Roth) IRA was created or just the amount earned between the conversion to a Roth and the distribution to the beneficiary? If the former, then all of the earnings up until the time of the conversion would be taxed twice – once to the person who held and converted the IRA and once to the beneficiary. That seems to be what is on the 1099 but doesn’t seem right.
Best discussion of these issues I have read. Thanks for posting.
Very well written article! Best explanation of the 5-year rule I have found so far.
Example 1 in this post leaves out a very important qualification though: suppose that the $50K in Jeremy’s traditional IRA came entirely from none-deductible contributions, some of which were made within the last 5 years. Further suppose that for whatever reason there are no earnings in this $50K, maybe market fluctuations have resulted in $50K contributions over the last 10 years to result in a balance of $50K today or maybe Jeremy invested his traditional IRA funds in a very low-risk, low-return asset, knowing that he would convert it to Roth later and only after conversion would he switch to higher-return assets that can grow tax free. As per IRS publication 590 (http://www.irs.gov/publications/p590/ch02.html#en_US_2013_publink1000231064) Jeremy is allowed to convert the entire amount to a Roth IRA and subsequently withdraw the entire amount tax free and penalty free: “You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount).” In Jeremy’s case the no part of the the conversion amount needed be included in income when he converted, as such no part is subject to taxes or penalty upon distribution.
Based on this, I think this sentence under managing the five-year rule section of the post deserves some clarification: “even if the withdrawal is principal and not subject to ordinary income taxation, if it is a conversion amount within the 5-year time window, the withdrawal may be subject to early withdrawal penalties even if it is not otherwise taxable.” -> but would not be subject to early withdrawal penalties if the entire withdrawal can be attributable to conversion funds that were not subject to taxes at the time the conversion happened.
I think you may have answered my question but I’m hoping I may double check.
I had a Traditional IRA that was funded 100% with non-deductible contributions. I immediately converted it into a Roth and there were basically no earnings. Inside the Roth there have been some earnings. In the same year (this year), I find I need to withdraw the contributions (not the earnings). I’m being told different things about whether I can remove the principal penalty free given I converted it to a Roth. Can I withdrawn the money penalty free? Thanks.
Wayne,
No, you cannot withdraw the principal penalty-free. Or at least, not merely because it was a Roth conversion. You are subject to the 5-year rule.
If there is ANOTHER reason you can avoid the early withdrawal penalty on the principal – e.g., because you’re already over age 59 1/2 – that would work.
Basically, if you would have been subject to the early withdrawal penalty from your IRA in the first place, you’re still subject to it from the Roth IRA, because the Roth conversion has not aged by 5 years.
– Michael
Michael,
Thanks for the response.
To clarify, you note if I would have been subject to the early withdrawal from the IRA in the first place I would under the Roth. I guess that’s my point. My contributions were 100% with after-tax money and my understanding is that the principal could be withdrawn anytime, penalty free, for this reason. Isn’t the above post saying the same is true even if it was a conversion?
I am thinking I could re-characterize the conversion and get my principal back? I’m not talking earnings. I’m talking 100% non-deductible contributions.
If the Roth conversion came from traditional IRA funds that were NOT tax deductible, is the 5 year rule off the table? That is, I need to tap some Roth IRA funds that I converted from my IRA earlier this year but my IRA was non-deductible due to income level. Thanks.
Thank you so much for this excellent and concise summary of the rules! I’m particularly thankful because it corrects the bad advice I just received from a Vanguard associate, regarding my ability to withdraw my Roth IRA conversion money, penalty- and tax-free, to help pay for a house I’m buying. In a nutshell, I opened my Roth IRA with a conversion of $30,000 in traditional IRA money in Dec 2014. I listed it as an early distribution, exception applies, and paid tax on this “income” in Apr 2015, but no penalty. As I understand it, being only 57.5, and with no exception applying to me, I have to wait until Jan 1 2019 to take that money both tax- and penalty-free. However, seeing as I turn 59.5 in July 2017, I could take it then without penalty, AND without tax on the portion of the $30k that is considered my own “contribution”. Hopefully I have that right. (My Vanguard associate believed I could take it immediately, without tax or penalty. At least she provided the caveat, “I’m not a tax professional”.) So, here’s where I get confused — how does one know what portion of the money in their Roth account is characterized as “contribution” and what portion is “earnings”? Keep in mind that this $30k was converted from a traditional IRA, which itself was created by a conversion from a company 401(k), and so any history of which portion came from where is (seemingly) lost.
First, thank you for all of the great information. I still have a question if you are able to help: I have $101,000 in a 401K account now from a previous job. I want to withdraw about half of that and was thinking that the penalties would be much less if I did so from a Roth IRA. If I roll the entire 101,000 into a Roth IRA and then withdraw 25,000 from the Roth IRA almost immediately, what would my penalty be (for rolling into the Roth IRA and for the withdraw)? Thank you again for your help.
Brian,
You’ll pay income taxes on the Roth conversion. If you’re not already over age 59 1/2 (or otherwise exempt from the early withdrawal penalty), you’ll pay a 10% early withdrawal penalty on the withdrawal from the Roth IRA because you haven’t met that 5-year rule.
Which means you’ll have the EXACT same outcome either way. You’re going to pay income taxes (as a withdrawal or a conversion) and you’re going to pay an early withdrawal penalty (from the 401(k) or for taking from a Roth conversion without waiting the 5-year period).
That’s actually the whole point of these rules – to make the outcomes the same. You’d have to wait at least 5 years from the conversion to get to that conversion principal penalty-free.
– Michael
Thanks for putting together such a great, comphrensive article! One question, though: In regard to an Inherited Roth IRA you say, “death is an exception to the early withdrawal
penalty, any beneficiaries taking distributions from a Roth IRA will always
enjoy penalty-free treatment (regardless of whether it’s principal or earnings,
and regardless of whether the 5-year rule for conversions has been met or not).
On the other hand, death does not eliminate the 5-year contribution rule for earnings to be tax-free!”
Does the 5 year conversion rule also apply here as well?
Thanks,
Liz
I have a quick (probably not) question. I converted a traditional to a roth in 2010. At the time you were able to split the amount of tax paid over the following two years (2011 and 2012). I opted to do this. I am looking to withdrawal some of the principle of that converted roth. Does my five year clock start Jan 1, 2010 (year of the conversion) or does it start Jan 1, 2011 (since thats the year i began to pay taxes on it)? Basically asking the question, am I able to withdrawal principle this year without penalty or do I need to wait until next year (2016)?
Great article and thanks in advance if you are able to help with my question.
Thanks for the explanation!
Does the second 5-year rule apply when the funds coming into the Roth IRA were totally post-tax (e.g. from a solo Roth 401(k))?
In other words, if I roll over (or is the term convert?) my entire solo Roth 401(k) into my Roth IRA, can I withdraw that money (that came from the 401k) from the IRA without penalty without waiting 5 years?
I have a Roth IRA that’s been open for 7 years. In addition, I have been contributing to a Roth 401(k) for around 2 years. I recently left that employer and rolled the Roth portion into a separate Roth IRA (which now appears to have been unnecessary). I am now trying to pull as much money from principle contributions as possible for a down payment (but NOT a first time home purchase). Obviously I can get at my principle from the original Roth IRA as it has satisfied the 5-year rule. Am I able to pull principle from the 2nd account as well, or does it not qualify because the Roth 401(k) was not opened 5+ years ago?
Mike, great explanations! I also have a question. In 6/2013, I converted my Traditional Roth to a Roth IRA. Paid my dues on all that, but, now if I want to “Exchange” my Roth IRA to Money Market Funds do I have to wait until the end of the 5 years (2019) or will I have to pay tax and penalty if I do it sooner?
Cathy,
As long as the money stays IN a Roth IRA, it doesn’t matter how it’s invested. You can change your investments anytime you want to inside the Roth account itself (including to a money market fund).
– Michael
Thanks so much for your quick reply!
Excellent work Mike. Your page came up #1 on Google during my search so you’re obviously doing something right!
This is the best and most complete article on Roth reg’s I have ever read – thanks! One unclear scenario – if I have my own Roth (more than 5 yrs old) and I inherit a less-than-5-yr-old converted Roth, is my tax situation consistent with your article’s explanations or does the inherited Roth exist in its own universe, as if I did not already have a Roth in my own name? Again, many thanks for a great wealth of information, clearly presented.
How do I show the IRS that my ROTH IRA distribution is qualified? My financial institution does not track the 5 year holding period so they report the distribution as a “T” since I’ve reached 59 1/2.
Your tax forms (including the 5498 issued by your custodian) are the record.
Finally a GREAT Roth article and discussion following!
I have a 20 year old Roth. I just started another Roth at a different institution. It is easy to show the 5 year rule from the 20 year old Roth from records from the institution but I would like to close the 20 year old Roth account and move all the money to the new Roth that is at a different institution and only started a month ago. Will I be asked by the IRA to prove my 5 year is satisfied? Or does the IRS know this from past taxes where the Roth contributions were claimed on my income taxes? I’m just worried since I’m already at retirement and want to withdraw the money soon and that the IRS will want to tax me.
If I rolled over my Roth 401k to a new Roth IRA, how are my contributions tracked? Is it based on the contributions I made to the Roth 401k or the amount that I rolled into the new Roth IRA? I am trying to understand the tax implications from taking distributions from my Roth IRA.
Thanks very much for that detailed explanation. I’m hoping I can get a confirmation of my understanding from you, just to be sure I don’t make a costly mistake.
I’m now 58 and a half years old, retired, and I’ve done two Roth conversions from my traditional IRA: $30k in 2014 and $12k in 2015, because it made such great tax sense. As I understood it at the time, the Roth conversion 5-year rule meant that I couldn’t touch either amount until 1/1/19 and 1/1/20 respectively, without a tax penalty. And if I waited the full 5 tax years, then I’d satisfy the conversion 5-year rule, and I’d be 61 (i.e., over 59.5 years old).
Now (from above) I understand that in my case, I could withdraw the principal (only), $42k, penalty-free, after my 59.5 “birthday” in July 2017, and not have to wait the full 5 years, because I’d already satisfy an exception to the penalty. Have I got that right? I’d love to withdraw the principal to pay off my remaining mortgage early, rather than having it sit in my Roth IRA for another 1.5 (and 2.5) years. Thanks!
My wife and I are looking to purchase a house using our IRAs as First Time Home Buyers. She has a traditional IRA ($16,000) and I have a Roth IRA ($7,000). Under the first time home buyers rules the accounts have to be open for 5 years. Does that apply to specific institution accounts or just the life time of the IRA being open?
Both of our IRAs have been moved between a few institutions as our financial advisor has moved employers. I opened mine over 15 years ago and haven’t contributed anything in over a decade. I’m sure my wife has not contributed in over 5 years. Can we even use that money since it’s all mostly earnings? How is the age of the account determined? I don’t claim contributions on taxes because there aren’t any.
First of all – great article. Now my question – I am more than 59 1/2 years old, have a Roth IRA established over 5 years ago and a Roth 401(k) established for my consulting business approximately 3 years ago. Can I make a partial transfer of monies from my Roth 401(k) plan to my Roth IRA without any tax or subsequent withdrawal consequences? I want to continue making contributions to my Roth 401(k) plan in the coming years but want to keep the overall value of the account below a certain level to avoid IRS plan reporting requirements. Thanks.
I remember reading about this but is rarely mentioned. after 59/12 and 5 year rule, all gains are tax free, am I right? eg. if I had been contributing to Roth IRA or Roth 401k since 2011 and I am 63 yrs old now, if total contributions amounted to $100,000 and I gained $10,000, $110,000 are tax free?
I have a roth that I contributed to in FY 2015. I am considering rolling over a 401k into my roth in 2020. Will I be able to withdraw the conversion in 2020 without a penalty or will I need to wait until 2025 to touch the conversion dollars without penalty despite the roth having been active since 2015? It seems like under the rules I would first tap into roth ira contributions then be able to touch the conversion contribution in 2025 as means of accomplishing both five year rules? Thank you!
Your discussion about the conversion waiting period is missing a detail. The detail is: if you make an nondeductable (after tax) contribution to a traditional IRA, then roll over to a roth IRA, then withdraw, there is no penalty on the portion of the withdrawal money that came from the original after tax contribution to the traditional IRA. No 5 year waiting period applies to that money.
The table here from KAWill explains under what circumstances your roth IRA withdrawal is taxed and/or penalized: http://fairmark.com/forum/read.php?2,63970
Does a rollover from a Roth 403(B) plan to a new Roth IRA incur the same restrictions (i.e. resetting the 5 year clock) as a Roth 401(K)? (The Roth 403(B) plan already meets the 5 year criteria)
I’m familiar with how the conversion would work from a Traditional TSP rolled into a traditional IRA and then converted to a Roth IRA, then waiting 5 years to satisfy the 5 year rule for conversions. My question is, can this be done by rolling a Roth TSP into a Roth IRA, and then just waiting 5 years. I’m assuming that’s equal to asking can you do the same by rolling a Roth 401K into a Roth IRA and then wait 5 years.
Michael,
If someone is over 59 1/2, rolls their Roth 401(k) balance to a Roth IRA, does the 5-year rule still apply to the earnings portion to be tax-free? Also, earnings need to be tracked since first Roth 401(k) contribution and carried over to the Roth? Or only on earnings made after the rollover?
I have a question. I have a lady age 50 who had a Roth 401k at her old employer. The basis is 100k and the account has 100k of earnings. If she rolls the 200k to a Roth IRA, what will be the tax consequences if she withdraws less than her basis? Will she have to pay the 10% penalty because the Roth IRA is not 5 years old?
How does the 5 year rule apply to Roth conversions if the owner dies and leaves the money to his children? For example, a person converts $30,000 from a standard IRA to a Roth in 2020 and dies a year later. How does the 5 year rule come into play for his 40 year old beneficiary?
I have read and understand the both 5 year scenarios, however; the scenarios are about employers IRA’s. What about after tax dollars into an IRA not funded by an employer?
Thanks for the thorough article! Can you please elaborate specially the classification of a rolled-over Roth IRA?
For example, if I’ve had a Roth IRA for more than 5 years and rolled over money from my Roth 401k into the Roth IRA (no tax due of course), would that money be considered Contribution or Converted fund in the order of withdrawing that you mentioned?
Thanks!
I have a scenario where I put a total of 20k of contributions into my IRA over the years. I have earned a total of 100k. If I rollover 60k into the Roth IRA (I get taxed completely). If I wait 5 years, how much of the 60k is determined for contribution. The cost basis is 20% so is 12k tax-free since it is a contribution or is all 60k tax-free since I paid taxes and is now tax-free because of Roth Ira 5-year tax exemption. Please let me know.
Good article.
To be sure I understand you, is it correct that if I (over age 59 1/2) roll over $1,000 to my new sole Roth, I can take out that $1,000 within the next 5 years, without furher Income Tax or 10% penalty/additional income tax?
Hello
I have a question about a very specific situation but was not sure where to post it. I will also seek advice from a CPA
I have a roth ira that <5 years old, the money was put in from a multiple retirements (which I had contributed to in various years and had earnings) that was done through a backdoor roth ira conversion and from post tax roth traditional ira money that was converted into the roth ira. All that money is now in my roth ira. I have had 50% earnings over the past 3 years. I want to withdraw my contributions from the roth IRA. I never had an initial roth ira to begin with to which I contribute money so this is all roll over money with pretax and post tax sources.
If I withdraw the amount that I converted over only would I only have to pay a 10% penalty, how does the pro-rata rule apply
Per the IRS website
https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts#Distributions
“If you take a distribution from your designated Roth account before the end of the 5-taxable-year period, it is a nonqualified distribution. You must include the earnings portion of the nonqualified distribution in gross income. However, the basis (or contributions) portion of the nonqualified distribution is not included in gross income. The basis portion of the distribution is determined by multiplying the amount of the nonqualified distribution by the ratio of designated Roth contributions to the total designated Roth account balance. For example, if a nonqualified distribution of $5,000 is made from your designated Roth account when the account consists of $9,400 of designated Roth contributions and $600 of earnings, the distribution consists of $4,700 of designated Roth contributions (that are not includible in your gross income) and $300 of earnings (that are includible in your gross income).”
I really don’t understand this, say I have 200K in backdoor conversions (pretax dollars) and 18K post tax dollars that was converted to a roth IRA and now I have 350k in the roth IRA(including earnings of 132K)
Thank you so for the confusion but this might explain it better.
Superbly written. To date, it provided the only very clear answer to my converting to a Roth from a Traditional IRA and withdrawing principal after age 59 1/2. Thank you so much!!
We have Roth IRA’s in stocks that pay dividends. The dividends have been reinvested since 2010. I max contribute to both Roth accounts every year, as I still work. We intend to live off the cash dividends and not touch the principal and reinvest any extra back into stock. Do cash dividends work as a distribution and how would that tie into the 5 year rule?
Does this 5 Yrs rule apply to all the brokerage accounts or where the money is currently deposited? At the current brokerag it has been opened only for 2 yrs, but the initial brokerage at another firn, the account has been opened for over 10 yrs. Thank you
I am confused. If we had a traditional IRA conversion to Roth and waited 5 years. Can we withdraw our original contribution tax penalty-free before 59.5?
Hi Michael, thanks for the great article. It’s a growing a little long in the tooth, and I want to be very sure I understand how conversions work, so pardon what might be a repetitive question.
Assume a person who is over 59.5, does a conversion of say $100,000 from a traditional IRA to a Roth IRA and pays all income taxes on the conversion. Over the next six months, they have $5,000 in earnings on the Roth IRA balance. Can that person take both the principal and any earnings out immediately without penalty? All $105,000 with no penalties, and no taxes?
I realize it may be unusual to actually do a conversion if you really thought you would need the money almost immediately, but emergencies happen and I want to make sure there is flexibility.
By the way, I followed your citations to the IRS code in your article (thank you for including!), but I still had a hard time identifying the specific language that answers my question. If at all possible, please identify what your rely on from the IRS code for your response.
Great stuff as always, and thanks for your help!
@joe_petry:disqus No, the earnings would not necessarily be tax-free in this situation.
In order for earnings to be tax-free, the individual must be over age 59 1/2 (or deceased, or disabled), AND must have had at least SOME Roth IRA for at least 5 years. If they had another Roth IRA already, that 5-year requirement would be satisfied, and the growth would be tax-free. If they did not already have a Roth IRA (and this Roth conversion was their first), they would only be 6 months into the 5-year requirement, which means the growth would not be tax-free.
– Michael
Excellent, Michael. Thank you for the clear explanation!
I have a Roth IRA over 5 years old. I am 72 and retired with no working income. I have to take a RMD this year. After I do that, can I roll over IRA funds to the Roth in the same year and is every such rollover subject to a different 5 year term?
Does the second 5-year rule apply when the funds coming into the Roth IRA were totally post-tax (e.g. from a solo Roth 401(k))?
comment brought to you by: concrete Billings MT
Hi Michael, Question regarding the 5-year Roth conversion rules. Just confirming my reading of the article –if you were over age 59 ½ and did a Roth IRA conversion, and then withdrew funds within 5 years of the conversion, that it is both penalty free & income tax free. I ask because the following information on Investopedia, seems to contradict this and say that income taxes would apply to the earnings– did I misread your article? Can you please help to clarify this?
(From Investopedia — Does the 5-Year Rule Apply to Roth Conversions After Age 59½?
Yes. Even if you’re over age 59½ when you withdraw, some of your withdrawals could get included in taxable income, thanks to the five-year rule. You won’t owe the 10% penalty in that case, but you’ll still owe tax on any withdrawals above the amount contributed.)
Thank you!
Adding a fact to my question — The individual had an existing IRA that was at least 5 years old. Thanks!
Existing Roth IRA in existence for over 5 years!
This is far and away the best explanation I have come across on ROTH conversions and withdrawals and tax/penalties. So many of the other sites fail to mention that if you have multiple ROTHS, your first contribution to any on them starts that main 5 year clock. They all seem to default to a conversion being your first ROTH.
Many years ago my wife and I started Roths. Once we passed a certain threshold of earnings we were not allowed to make additional Roth contributions.
If we now, for the first time, make IRA to Roth conversions at age 71-73 will the earnings the Roth conversion be subject to taxation, if the earnings are withdrawn within 5 years of conversion even though are way over age 59.5. Who is right and can you site the section of the law on what is true? Thanks. Fidelity says they would be taxable but other finance specialists say they are not. Help!