You may have heard of the 5 Year Roth IRA Rules when it comes to Roth IRAs. In my findings, many individuals can get tripped up on what this rule is, and it can have some negative tax consequences if not properly understood and executed.

There are actually 2 different Roth IRA “5-Year Rules.” One will apply to Roth IRA Contributions, and one applies to Roth Conversions. Let’s start with some background.

3 Types of Dollars in a Roth IRA

Any Roth IRA will have funds that can be classified in one of three ways.

Those include:

Contributions
Conversions
Earnings.

Contributions

This is the after-tax purchase you make into your Roth IRA. Contributions are subject to an annual limit. There’s also an income limit for individuals and couples (married filing jointly).

Since contributions are made with after-tax dollars, contributions can be removed from a Roth IRA at any time income-tax free and penalty-free. In order to make a contribution to a Roth IRA, you also need to have earned income.

Conversions

Roth IRA Conversions are converted from another source, most commonly a Traditional IRA or 401(k). Unlike Contributions, there is no annual conversion limit amount, income limit, or requirement of earned income.

The catch is that you must pay the associated income tax due on the conversion in that year.

Since pre-tax holdings have not been subject to income tax, they must be paid at the time of the conversion.

You can either withhold the taxes on the conversion itself (meaning the net figure invested into the Roth IRA would be lower), or pay the tax from another source.

You may also be subject to state taxes depending on your state of residence.

Assuming you complete the Conversion successfully, there is no 10% penalty that would apply to this conversion.

If you’re under 59.5, if you withhold funds from your pre-tax account, it is subject to the 10% penalty and considered a taxable withdrawal. If you’re under 59.5 and are planning to complete a conversion, it is best to pay the tax from another after-tax source (savings account, brokerage account, etc.).

Earnings

The earnings within your Roth IRA represent the growth of your accounts. Assuming you satisfy the necessary 5 year rules, qualified withdrawals of earnings are tax-free.

The beauty of a Roth IRA is that it’s one of the only accounts that can allow for tax-deferred growth and tax-free earnings. But in order to make sure those earnings are tax-free, there are criteria that must be met.

How Do These Funds Apply to Distributions?

The IRS provides guidelines for how Roth IRA distributions are classified. Contributed dollars, converted dollars and earned dollars are all tracked, and how they are distributed determine if any penalty or income tax apply.

The Order of Distributed Dollar

When a distribution takes place from the Roth IRA, it follows this order:

Contributions come out first
Then Conversions
Then Earnings

Penalties Applied to the Distributed Dollar

Contributions can be taken out at any time penalty and tax free. Earnings and conversions are where the 5 Year Rules come into play.

5 Year Roth IRA Rule 1: The Conversion Rule

The first rule applies to Roth Conversions. Dollars converted from a Traditional to Roth account must be held for 5 years before they’re eligible to be accessed.

In the event you withdraw converted dollars improperly, you’d be subject to a 10% penalty (assuming an exception does not apply).

The rule applies to funds within the year, so for example, if a conversion takes place in December of 2024, the clock begins on January 1 of the year in which the conversion is made.

The reason this rule is in place is to ensure you don’t do a Roth Conversion from a pre-tax account, then follow it up with a tax-free withdrawal.

This rule applies to each subsequent conversion you would do.

This rule also affects the withdrawals of converted dollars of individuals under 59.5, but not withdrawals of converted dollars if you’re over 59.5. When it comes to earnings, that’s what the 2nd 5 Year Rule applies to.

If you’re over the age of 59.5 (or very soon to be), this rule is unlikely to affect you.

2 other quick items of note:

This rule applies to “Backdoor Roth Contributions” since these are technically conversions.
Conversions must be done in a calendar year, not the tax year (which extends to the following April).

5 Year Roth IRA Rule 2: The Earnings Rule

This rule is more applicable for individuals regardless of age (59.5 and older folks – pay attention!).

For a Roth IRA to have earnings distributed on a tax-free basis, the account holder must satisfy two rules:

Be over the age of 59.5
Must have had a Roth IRA open and funded for at least five years in his/her lifetime.

With this five year rule, the clock ticks as of January 1 the year in which you establish and fund the Roth IRA. So hypothetically, it could be a 3 and ¾ year rule. If you establish a Roth and make a prior year contribution (so long as it’s within the tax deadline), you can get the clock started.

As soon as this is satisfied with 1 Roth IRA, you as a taxpayer are in the clear. You can have multiple Roth IRA’s, but so long as one meets the criteria, all of your accounts are in the clear.

Why This Matters

This is especially applicable for individuals who may have oversaved into a pre-tax account.

If you’ve built a balance that has an impending Required Minimum Distribution (aka, the money the IRS requires you take out at a certain age), having a Roth IRA and some savvy tax planning can help to lower this required amount.

It’s also worth noting that just because you have a Roth 401(k), it does not mean that you have met this criteria. A Roth IRA and Roth 401(k) are treated differently, so it’s not a good idea to assume you’ve satisfied your 5 year requirement if you’ve only had a Roth 401(k).

Inherited IRA Rules still have this Penalty Apply

If you’ve inherited a Roth IRA, you also want to be aware of the applicable 5 year rules that the decedent left you.

For example, if a parent opened a Roth IRA for only 1 year, and passed away, leaving the account to his daughter, the daughter could access the contributions tax-free. However, the earnings would not yet be eligible for tax-free withdrawals.

Let’s take a look at some examples to better see how these apply in action.

5 Year Roth IRA Rules: Case Study 1

Charles is 58 Years old (December 7th birthday) and wants to start to do Roth Conversions since he’s over saved in his pre-tax IRA.

Charles opens his Roth IRA in December of 2024 right after his 58th birthday.
He doesn’t plan to do any contributions since he’s a very high income earner.
He immediately converts $20k from pre-tax to Roth.
Charles pays the associated income tax due from his excess savings, electing not to withhold from the pre-tax account.
The next December 7th, at age 59, he does another Roth Conversion of $20k.
He’s earned $10k since he’s opened the account.
He plans to take all of the funds from the Roth IRA that January to purchase a basketball court.

Let’s review how Charles’s distribution schedule will affect him:

Contributions are distributed first tax & penalty-free, but he didn’t make any contributions.
Conversions are removed next.
- Since Charles is under Age 59.5 at the time of the distribution, the first 5 Year Rule will apply.
- Charles is subject to a 10% penalty on the withdrawal of the converted dollars since he has not met the First 5 Year Rule of being under 59.5 & the converted dollars have been held under 5 years.
- Charles is also subject to taxable earnings as ordinary income and a 10% penalty on the earnings since he has not held the Roth IRA for the necessary 5 Years.

5 Year Roth IRA Rules: Case Study 2

Earvin has had a Roth IRA established since when the Roth IRA was first introduced in 1998.

Earvin was born on the same day as Charles (Age 58 – Dec 7th).
He’s contributed $60k over the years, and the account has done really well, earning $300k.
Earvin now wants to do Roth Conversions, however, since he watched a great YouTube video explaining how Roth Conversions work.
He decides to go small, and do a $10k Roth Conversion, and pays the tax due from his excess savings on his Age 58 birthday.
An opportunity arises that next January that he can purchase a baseball team, but he needs $61,000 from his Roth IRA to do so.
He takes a $61,000 distribution from the account.

Earvin is able to remove the contributions tax and penalty free, so $60k of his distribution is in the clear.

However, his move isn’t 100% magical.

Since converted dollars are removed next, he is subject to a 10% penalty on $1,000 since he is not yet 59.5 and hasn’t satisfied the first 5 Year Rule.

5 Year Roth IRA Rules: Case Study 3

Larry, much like his counterparts Charles and Earvin, is trying to come up with a smart tax plan. He has had a Roth IRA for 20+ Years, and has $50k of contributions and $500k of earnings.

Larry is also Age 58, with a December 7th birthday.
Larry decides to do a Roth Conversion on his 58th birthday of $100k.
He utilizes excess savings to pay the associated income taxes due.
Larry is planning to build a museum in honor of his late friend, Bill.
To do that, Larry needs $450k from his Roth to fund the project.
Larry plans to fund the project on his 59 ½ birthday, and takes the distribution then.

Larry is in the clear, with no penalty on the withdrawal. He has satisfied both rules since he has reached age 59.5 and has had the Roth IRA opened and funded for over 5 years.

Your Action Steps to Take

If any part of your tax planning involves Roth IRA Conversions or Contributions, the first thing you need to do is be fully aware of the 5 Year rules.

If you haven’t yet established a Roth IRA, and you’re planning one or both of these strategies, establishing an account is a good idea.

Thankfully, there’s no requirement that you have to fund an IRA with anything other than the minimum balance required by a custodian.

Starting the clock for both of these rules may work in your favor.

But keep in mind, the power of Roth IRA’s are in the long-term tax-deferral. If you’re able to defer distributions and let these account compound, it can create a tax-free income stream for you and your family and provide a powerful tool in your retirement planning.