What Is the Roth IRA Five-Year Rule?

Information on Roth IRAs often refers to the “five-year rule,” but in fact there are two separate five-year holding requirements that may affect the tax treatment of Roth distributions. The first determines whether a withdrawal of earnings will be tax-free, and the second determines whether a withdrawal of converted principal will be penalty-free.

Withdrawal of Earnings

You can withdraw contributions to a Roth IRA at any time without tax liabilities or penalties, because contributions are made with after-tax dollars. However, to qualify for a tax-free and penalty-free withdrawal of earnings, the distribution must take place after age 59½ (with exceptions for death, disability, and up to $10,000 for a first-time home purchase) and meet the Roth earnings five-year rule.

The five-year holding period for earnings begins on January 1 of the tax year for which you made your first contribution (regular or rollover) to any Roth IRA you own. For example, if your first Roth IRA contribution was designated for tax year 2016 (even if made in early 2017), your five-year holding period began on January 1, 2016, and will end on December 31, 2020. You have only one five-year holding period for determining whether distributions from any Roth IRA you own are qualified tax-free distributions. Inherited Roth IRAs are subject to different rules.

Converted Principal

When you convert assets in a traditional IRA to a Roth IRA, the amount you convert (except for any after-tax contributions you’ve made) is subject to income tax in the year of the conversion. If you withdraw any portion of the converted amount within five years, you may have to pay the 10% early-distribution penalty on those funds, unless you’ve reached age 59½ or qualify for an exemption. This five-year holding period starts on January1 of the year you convert assets to a Roth IRA. If you have more than one conversion, each will have its own separate five-year holding period for this purpose. This rule also applies to assets rolled over from a qualified (tax deferred) retirement plan such as a traditional 401(k) to a Roth IRA.

These guidelines may be helpful, but Roth distribution rules are complex. Be sure to consult your tax professional before taking any specific action that might have tax consequences.

 
Waddell & Reed
1010 Stony Hill Road Suite 250 Yardley, PA 19067
Securities and Investment Advisory Services offered through Waddell & Reed, Inc., a Broker/Dealer, Member FINRA/SIPC and a Federally Registered Investment Advisor.

Insurance products are offered through insurance companies/agencies with which Waddell & Reed has sales arrangements.

Investment and Insurance products offered through Waddell & Reed, Inc. : Not FDIC/NCUA Insured • No Bank Guarantee • May Lose Value

The information on this site is for general informational and educational purposes only and is not to be considered an individualized recommendation or personalized investment advice. Please consult a professional prior to making financial decisions and keep in mind that investing involves risk including the potential to lose principal.

This site is published for residents of the United States only. Financial Advisors of Waddell & Reed, Inc. may only conduct business with residents of the states and/or jurisdictions in which they are properly registered. Therefore, a response to a request for information may be delayed. Not all of the products and services referenced on this site may be available in every state and through every advisor listed. For additional information please contact the advisor(s) listed on the site, visit the Waddell & Reed, Inc. corporate site at www.waddell.com, or contact the Waddell & Reed compliance department at 800-532-2762.

Much of the content provided on this site written and provided by Emerald Connect, LLC. Waddell & Reed, Inc. and Emerald Connect, LLC are not affiliated companies.

Privacy Policy