5 Year Rule for Roth Conversions

The second five-year rule determines whether the distribution of capital from converting a traditional IRA or a traditional 401(k) into a Roth IRA goes unpunished. (Remember, you have to pay taxes when you switch from the pre-tax funded account to the Roth.) As with contributions, the five-year rule for Roth conversions uses taxation years, but the conversion must be made no later than December 31 of the calendar year. Two criteria must be met for a distribution to be eligible. One test is that five tax years must have passed since the first contribution to a Roth IRA was made for the taxpayer. The five-year roth IRA rule states that you cannot withdraw income tax-free until at least five years have elapsed since you first contributed to a Roth IRA account. This rule applies to anyone who contributes to a Roth IRA, whether they are 59 and a half or 105 years old. Each subsequent Roth IRA is considered to have been detained for five years. Bearings from one Roth IRA to another do not reset the five-year clock. However, there are a few important rules that govern Roth IRAs. Specifically, the five-year rules are a set of rules that determine the penalty and tax eligibility of your Roth IRA payments. These details only apply to Roth IRAs. For Roth 401(k)s, the rules are slightly different. I will not come back to that now.

There is a second five-year rule that applies when you convert a traditional IRA to Roth IRA. When you convert a traditional IRA to Roth IRA, you pay taxes. The question is whether you are going to pay the 10% penalty. Every time you make a conversion, you create a new five-year period. To avoid the penalty, you can only use your contribution income after the end of the five-year period, which expires on 1. January of the year in which you first contributed to the IRA begins. The scheduling rules also stipulate that contributions are distributed first, then converted amounts and finally income are distributed. As the name suggests, the second 5-year rule does not apply to Roth (new) contributions, but to Roth conversions of traditional pre-tax pension accounts and determines whether Roth conversion capital is exempt from sanction.

But another rule cancels this five-year rule for most people who convert traditional IRAs to ROTH IRAs. This is because the 10% early distribution does not apply once the owner is at least 59 and a half years old. The 5-year rule essentially states that five taxation years must elapse from the time the first contribution is made to (any) Roth IRA until a qualified distribution can be made. Since the measure is based on taxation years, this means that a contribution (not just a rollover, but a new actual contribution) to a Roth IRA still counts as a contribution to the 2013 taxation year until April 15, 2014 (essentially, it counts as if the contribution was made on January 1, 2013). This means that the first year of a potentially eligible distribution would be 2018 (as the five years that passed would have been 2013, 2014, 2015, 2016 and 2017). In particular, this means that an eligible “5-year” distribution could actually be made after less than 3 years and 8 months, as a contribution on April 14, 2014 (in 2014, but for 2013) would allow tax-free distributions as of January 1, 2018. Keep in mind that this five-year rule only exposes you to prepayment penalties that would otherwise apply. If you have reached the age of 59 and a half or if another penalty exception applies, you will not be punished – even if the five-year prison sentence has not yet expired. These exceptions are for first-time buyers and unreasonable medical expenses, to name a few. A glimmer of hope: The clock starts ticking on the first day of the year you make the conversion, regardless of when the conversion actually took place. For example, you could run the conversion on December 15, 2020 and the five years would have expired on January 1, 2025.

So essentially, and compared to Tim`s specific situation, the 5-year holding period does not apply after 59.5 years compared to the 10% penalty for converted principles. The answer was confusing. What am I missing? This five-year rule also starts the watch on January 1 of the year you make the conversion. As a result, those who convert at the end of the year only have to wait a little more than four years before making withdrawals. You must pass both tests for a Roth IRA distribution to be free of income tax. For example, if you`re at least 59 and a half and have had a Roth IRA for at least five years, the distribution is qualified and tax-free. In addition, each employer-sponsored plan is subject to its own 5-year rule in the event that someone has multiple Roth accounts under multiple workplace pension plans.