Weekend Reading: What You Need to Know About the Confusing Roth IRA Five-Year Rule

This article appears as part of Casey Weade's Weekend Reading for Retirees series. Every Friday, Casey highlights four hand-picked articles on trending retirement topics and delivers them straight to your email inbox. Get on the list here.
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Weekend Reading

If you’re considering converting your traditional retirement account to a Roth IRA, there are tax considerations within the “Five-Year Rule” to be aware of.


The complexities of converting: In order for future distributions from a Roth IRA to be tax-free, they must be considered qualified distributions, which also means meeting the five-year-rule. What makes this so complicated for many? In reality, there are two rules, and they only apply to the original Roth IRA owner:

📌The five-year rule for income taxes – This determines if a distribution of earnings passes the test to be qualified, or free of income taxes. In order to be qualified, two tests are conducted: One, five tax years (not calendar years) must have passed since the first contribution (direct or converted) was made to any Roth IRA. Two, the distribution must be made on or after a specific triggering event, as listed in the article.

📌The five-year rule for the 10 percent penalty – This dictates if a distribution of principal from a converted IRA faces the 10 percent early distribution penalty. It applies separately to each IRA conversion, but if at least five tax years have passed since the principal was converted, or the owner is at least age 59 ½, the rule is not enforced.

My advice: Open a Roth as early as possible, and don’t get too wrapped up in the “Five-Year Rule”. It most likely won’t apply, and isn’t worth stressing over if you’re truly concerned about rising taxes.