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Roth IRA Five Year Rule

The Roth IRA Five Year Rule has two separate five-year holding requirements that may affect your taxes. The first rule determines whether a withdrawal of your increases will be tax-free. The second rule determines whether a withdrawal of converted principal will be penalty-free.

Withdrawals

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

The five-year holding period for monies earned begins on January 1 of the tax year for which you made your first contribution (regular or rollover). For example, if your first Roth IRA contribution was designated for tax year 2016, your five-year holding period will be January 1, 2016 to 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 that money, 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. The Roth IRA Five Year 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.

Freeman Owen, Jr -Retirement Specialist

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