Q. I’m trying to understand the rules on IRA to Roth conversions. I was under the impression the five-year rule on conversions doesn’t come into play once you are 59 1/2 and if the Roth account had been open for at least five years. Or do you still have to wait five years to access the Roth funds without extra taxes?
— Investor
A. We know IRA rules can be confusing.
Here’s what you need to know about your Roth.
You are permitted to withdraw your contributions at any time, both tax- and penalty-free, said Marnie Hards, a certified financial planner with Aznar Financial Advisors in Morris Plains.
The rules are different for the growth in excess of the contributions made to the account, she said.
If you want to withdraw money in excess of your contributions from your Roth IRA that you have had for less than five years and avoid the 10% early withdrawal penalty, you can do so in the following situations:
- You use up to a $10,000 maximum (over the course of your lifetime) to pay for a first-time home purchase.
- You use the money to pay for qualified education expenses.
- You use the funds for qualified expenses related to a birth or adoption.
- In the event of death or disability.
- You use the money to pay for unreimbursed medical expenses or health insurance if you are not employed.
- The distribution is made in substantially equal periodic payments.
But if you withdraw from a Roth IRA that you have had for more than five years and are under 59 ½, you can avoid taxes and penalties on the distributions for the same reasons listed above, Hards said.
“If you are over 59 ½ and you have had the Roth IRA for less than five years, your earnings will be subject to income taxes, but not to early withdrawal penalties if you take a distribution,” she said. “If you are over 59 ½ and have held the Roth IRA for more than five years, you avoid both income taxes and penalties on the distribution.”
Hards said the clock for the five-year rule starts the first time any money is contributed into any Roth IRA. A new five-year clock does not start each time another contribution is made, she said.
This applies to Roth IRAs but not Roth 401(k) plans. If you roll a Roth 401(k) over to an existing Roth IRA, this will begin a new five-year period on the Roth 401(k) portion, she said.
So, once you satisfy the five-year requirement for your Roth IRA, it has been permanently satisfied and future contributions or conversions — as long as they are not from a Roth 401k — will not need to satisfy a new five-year rule.
Keep in mind that the five-year rule essentially states that five tax years must pass from the time the first contribution is made until a qualified distribution can be made, Hards said.
“Due to the fact that the measurement is based on tax years, this means that a new contribution to a Roth IRA — as late as April 15, 2016, as an example — will still count as a contribution for the 2015 tax year — essentially assuming a contribution of Jan. 1, 2015,” she said. “This means that the first potential qualified distribution would be 2020 since five tax years would have passed (2015, 2016, 2017, 2018 and 2019).”
So technically, three years and eight months later, the tax-free distributions could be made, or as early as Jan. 1, 2020, she said.
Email your questions to [email protected].
This story was originally published on Aug. 20, 2021.
NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.
