Five-Year Rule for Roth IRA Withdrawals: A Primer
I've never seen so much confusion about a financial topic as with the five-year rule for Roth IRA withdrawals.
Countless readers believe incorrectly that they can't withdraw money that's been in their Roth IRAs less than five years, whether it came from a direct contribution or a conversion from a traditional IRA. (This mistaken belief deters many from considering a conversion.) Others realize they can make withdrawals before five years -- actually, at any time -- but believe they will owe taxes and/or penalties, which isn't always true.
Part of the confusion stems from the fact there are two different five-year rules, one for direct contributions and one for converted amounts.
Unfortunately, for the sake of brevity, the rules are almost always oversimplified and expressed incorrectly in the financial press (the rules, filled with jargon, are explained in
Let's start with direct contributions. It is stated often -- I've done it myself -- that you can take money out of a Roth IRA tax-free and penalty free "if the money has been in the account for at least five years and you are at least 59-and-a-half."
But that doesn't mean (the common misinterpretation) that all withdrawals made before 59-and-a-half and before five years are taxed or penalized. You can withdraw direct contributions at any time for any reason without taxes or penalties. If you have contributed
Also, for all withdrawals to be tax-free and penalty-free, the money does not really have to be "in the account for at least five years." The five-year holding period for direct contributions actually starts the first day of the tax year for which you made your first contribution to any Roth IRA account, not necessarily the one from which you are withdrawing the money.
Say you made your first Roth IRA contribution, no matter how small, on
With money converted from a traditional IRA, the rules get more complicated.
When you convert, you are taxed as if you just withdrew money from the traditional IRA but without any 10 percent penalty even if you're under 59-and-a-half. You can withdraw the converted amount at any time without paying any more regular taxes because you were already taxed on the conversion.
But since you avoided the 10 percent penalty on conversion, you will have to pay it if you withdraw the converted amount before age 59-and-a-half, unless you meet a five-year rule that applies to each conversion, or unless any of a dozen other exceptions listed on Publication 590 applies. Once you reach 59-and-a-half, the converted principal can always be withdrawn without taxes or penalties.
For all withdrawals from conversions to be tax-free (both converted amount and subsequent earnings), you must meet the conversion five-year rule. A separate five-year waiting period starts the first day of the tax year you make each conversion. If you made a conversion in 2009, even on
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Personal Finance - Five-Year Rule for Roth IRA Withdrawals: A Primer
(c) 2010 Humberto Cruz