I’m 68 and recently retired and have about $1.4 million in accounts intended for retirement ($1.2 million in a Traditional IRA and $110K in a Roth). I also am receiving about $47,000 annually in Social Security benefits. My RMDs are scheduled to start in 2027, and as a result, my financial advisor and I are considering doing some annual Roth conversions prior to 2027. It all sounds like a good plan to me, however, I am getting some conflicting information on when I will be able to make withdrawals from the Roth.
My advisor says I will have to wait the standard five years after each Roth conversion deposit before being able to make any withdrawal of those funds (the conversion amount itself and any earnings). However, I have also been told I could withdraw against the conversion amount with no waiting period since I am older than 59 ½. For example, my Roth was established in 2015 and has had a total of $60,000 in contributions and $50,000 in earnings. If I were to do a Roth conversion of $75,000 in 2024 would I then have available $135,000 for withdrawal without any penalty? My advisor says I would only have the original $60,000 available for withdrawal until the five years have passed for the conversion made in 2024. What is the proper withdrawal regulation and rules under those circumstances?
– Jeff
Hey Jeff, great question. This is unfortunately a very confusing topic that is easily jumbled up. It is not surprising that you’ve received or found conflicting information. Fortunately, once you sort through the rules and are able to keep them straight, the answer is very clear.
Because you are over 59 ½ and have had a Roth IRA for five years, you can withdraw any amount of money at any time from any Roth IRA balance you have (conversion or otherwise) without incurring a tax liability or penalty. Period.
Having said that, I am now just another guy that has given you information that conflicts with something else you’ve heard, right? Rather than leaving it at that, let’s walk through the rules and reference the specific information from the IRS. (And if you’re need financial advice or want to find a new advisor to work with, this free tool can help you connect with financial advisors who serve your area.)
What Are the 5-Year Rules?
While Roth IRAs are funded with after-tax money that can be withdrawn tax-free, there are specific rules surrounding how to take this money out of your account.
The IRS has three “five-year rules” for different types of Roth IRAs, but we’ll be discussing two of them here. The first five-year rule specifically applies to accounts that start off as Roth IRAs, while a separate five-year rule solely applies to accounts that are converted into Roth IRAs. Keep in mind that running afoul of either rule can trigger a 10% early withdrawal penalty and/or income taxes on investment earnings. You’ll obviously want to avoid these taxes and penalties as best as you can.
5-Year Rule for Roth IRAs
The first five-year rule dictates that you must wait five years after your initial contribution to a Roth IRA before you can make tax-free withdrawals of any investment earnings. However, the five-year period is retroactive to Jan. 1 of the year in which your first contributions were made.
For example, if you made your first contribution to a Roth IRA in November 2020, the five-year period officially began on Jan. 1, 2020. As a result, you could start withdrawing earnings after Jan. 1, 2025.
But waiting five years alone is only half of the equation. Withdrawals from your Roth IRA must be “qualified” in order for you to avoid taxes and penalties. Luckily, reaching age 59 ½ is the most common way to satisfy this particular requirement.
For instance, funding a Roth IRA at age 45 doesn’t mean someone can make tax- and penalty-free withdrawals from the account five years later. They’ll need to wait until age 59 ½, be disabled or meet one of the other requirements set by the IRS for qualified withdrawals. Likewise, if you open your first Roth IRA when you’re 58, the five years still need to pass before you can withdraw the earnings tax-free. Simply turning 59 ½ isn’t enough in this instance.
Failing to meet both the five-year rule and the rules governing qualified withdrawals may trigger income taxes on the earnings you withdraw, as well as a 10% tax penalty. Jeff, because you opened your Roth IRA in 2015 and you are over 59 ½ years old, you have already satisfied both rules. Plain and simple.
(And if you need help managing your Roth IRA, consider connecting with a financial advisor who serves your area.)
5-Year Rule for Roth Conversions
There is also a separate five-year rule for Roth conversions. If a person is under 59 ½ years old, they must wait five years before they can withdraw any money that’s converted from a traditional IRA into a Roth IRA. And unlike the first five-year rule that only needs to be satisfied once, this rule applies to each individual conversion.
Fortunately, you aren’t subject to early withdrawal penalties by virtue of your age, so this five-year rule also doesn’t apply to you. You’ll automatically avoid the 10% penalty on withdrawals from a converted Roth IRA.
However, here’s the context and rationale for this IRS rule:
Someone who’s under 59 ½ is generally subject to an additional 10% penalty on distributions from IRAs. Without this five-year rule, someone could simply convert a traditional IRA into a Roth IRA (paying the taxes on the conversion, of course) and then immediately withdraw the money from the Roth IRA, thereby sidestepping the 10% early withdrawal penalty. The five-year rule on Roth conversions closes this potential loophole.
Keep in mind that each five-year period starts on Jan. 1 of the year in which the conversion was made. (And if you need help doing a Roth conversion, consider speaking with a financial advisor who can guide you through the process.)
Bottom Line
As they say, age has its privileges. Because you are over 59 ½ and have satisfied the Roth IRA contribution rule, you no longer have to worry about taxes or penalties on any withdrawals you take from your Roth IRA.
Tips for Finding a Financial Advisor
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Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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If you’re working with a financial advisor but you’re unhappy with the results, you can always consider finding a new professional to work with. Here are some tips for navigating this transition, including how to notify your current advisor about your decision and what you should do before breaking off the professional relationship.
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Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column. Questions may be edited for clarity or length.
Please note that Brandon is not a participant on the SmartAsset AMP platform, he is not an employee of SmartAsset, and he has been compensated for this article. Questions may be edited for clarity or length.
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Source: finance.yahoo.com