What Is the Roth IRA 5-Year Rule? Are There Exceptions?
The Roth IRA 5-year rule is one of the rules that governs what an investor can and can’t do with funds in a Roth IRA. The Roth IRA 5-year rule comes into play when a person withdraws funds from the account; rolls a traditional IRA account into a Roth; or inherits a Roth IRA account.
Here’s what you need to know.
What Is the Roth IRA 5-Year Rule?
The Roth IRA 5-year rule pertains to withdrawals of earnings from a Roth IRA. A quick reminder of how a Roth works: An individual can contribute funds to a Roth IRA, up to annual limits. For 2024, the maximum IRS contribution limit for Roth IRAs is $7,000. Investors 50 and older are allowed to contribute an extra $1,000 in catch-up contributions. For 2023, the maximum IRS contribution limit for Roth IRAs is $6,500 annually. Investors 50 and older can contribute an extra $1,000.
Roth IRA contributions can be withdrawn at any time without tax or penalty, for any reason at any age. However, investment earnings on those contributions can only typically be withdrawn tax- and penalty-free once the investor reaches the age of 59 ½ — and as long as the account has been open for at least a five-year period. The five-year period begins on January 1 of the year you made your first contribution to the Roth IRA. Even if you make your contribution at the very end of the year, you can still count that entire year as year one.
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Example of the Roth IRA 5-Year Rule
To illustrate how the 5-year rule works, say an investor opened a Roth IRA in 2022 to save for retirement. The individual contributed $5,000 to a Roth IRA and earned $400 in interest and they now want to withdraw a portion of the money. Since this retirement account is less than five years old, only the $5,000 contribution could be withdrawn without tax or penalty. If part or all of the investment earnings is withdrawn sooner than five years after opening the account, this money may be subject to a 10% penalty.
In 2027, the investor can withdraw earnings tax-free from the Roth IRA because the five-year period will have passed.
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Exceptions to the 5-Year Rule
There are some exceptions to the Roth IRA 5-year rule, however. According to the IRS, a Roth IRA account holder who takes a withdrawal before the account is five years old may not have to pay the 10% penalty in the following situations:
• They have reached age 59 ½.
• They are totally and permanently disabled.
• They are the beneficiary of a deceased IRA owner.
• They are using the distribution (up to $10,000) to buy, build, or rebuild a first home.
• The distributions are part of a series of substantially equal payments.
• They have unreimbursed medical expenses that are more than 7.5% of their adjusted gross income for the year.
• They are paying medical insurance premiums during a period of unemployment.
• They are using the distribution for qualified higher education expenses.
• The distribution is due to an IRS levy of the qualified plan.
• They are taking qualified reservist distributions.
5-Year Rule for Roth IRA Conversions
Some investors who have traditional IRAs may consider rolling them over into a Roth IRA. Typically, the money converted from the traditional IRA to a Roth is taxed as income, so it may make sense to talk to a financial or tax professional before making this move.
If this Roth IRA conversion is made, the 5-year rule still applies. The key date is the tax year in which the conversion happened. So, if an investor converted a traditional IRA to a Roth IRA on September 15, 2022, the five-year period would start on January 1, 2022. If the conversion took place on March 10, 2023, the five-year period would start on January 1, 2023. So, unless the conversion took place on January 1 of a certain year, typically, the 5-year rule doesn’t literally equate to five full calendar years.
If an investor makes multiple conversions from a traditional IRA to a Roth IRA, perhaps one in 2023 and one in 2024, then each conversion has its own unique five-year window for the rule.
5-Year Rule for Inherited Roth IRA
The 5-year rule also applies to inherited Roth IRAs. Here’s how it works.
When the owner of a Roth IRA dies, the balance of the account may be inherited by beneficiaries. These beneficiaries can withdraw money without penalty, whether the money they take is from the principal (contributions made by the original account holder) or from investment earnings, as long as the original account holder had the Roth IRA for at least five years. If the original account holder had the Roth IRA for fewer than five tax years, however, the earnings portion of the beneficiary withdrawals is subject to taxation until the five-year anniversary is reached.
People who inherit Roth IRAs, unlike the original account holders, must take required minimum distributions (RMDs). They can do so by withdrawing funds by December 31 of the 10th year after the original holder died if they died after 2019 (or the fifth year if the original account holder died before 2020), or have the withdrawals taken out based upon their own life expectancy.
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How to Shorten the 5-Year Waiting Period
To shorten the five-year waiting period, an investor could open a Roth IRA online and make a contribution on the day before income taxes are due and have it applied to the previous year. For example, if one were to make the contribution in April 2023, that contribution could be considered as being made in the 2022 tax year. As long as this doesn’t cause problems with annual contribution caps, the five-year window would effectively expire in 2027 rather than 2028.
If the same investor opens a second Roth IRA — say in 2024 — the five-year window still expires (in this example) in 2027. The initial Roth IRA opened by an investor determines the beginning of the five-year waiting period for all subsequently opened Roth IRAs.
The Takeaway
For Roth IRA account holders, the 5-year rule is key. After the account has been opened for five years, an account holder who is 59 ½ or older can withdraw investment earnings without incurring taxes or penalties. While there are exceptions to this so-called 5-year rule, for anyone who has a Roth IRA account, this is important information to know about.
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FAQ
Do I have to wait 5 years to withdraw from my Roth IRA?
Because of the Roth IRA 5-year rule, you generally have to wait at least five years before withdrawing earnings tax-free from your Roth IRA. You can, however, withdraw contributions you made to your Roth IRA at any time tax-free.
Does the 5-year rule apply to Roth contributions?
No, the Roth IRA rule does not apply to contributions made to your Roth IRA, only to earnings. You can withdraw contributions you made to your IRA tax-free at any time.
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