The Roth IRA 5-Year Rule

We talk a lot on this show here about Roth IRAs. You’ve probably heard us over the years mention this countless times and talking about how the benefits of these and all the various things that are out there. Today I want to take a couple minutes and talk about maybe one of the things that could catch you or maybe is an unknown piece that we want to be aware of when we’re talking about Roth IRAs either through contributions or conversions. So with Roth IRAs, there’s something out there called the five-year rule. Meaning that, as you make a contribution, we’ll talk about first and then we’ll get to conversions, but as you make a contribution to a Roth IRA, there’s a five-year waiting period before you can truly get the tax-free distribution on the back end. And they look at this as a tax year. So what does that mean? So if I may a contribution to my 2023 Roth IRA, and that’s the first time I’ve ever opened that account and that’s the first contribution I’ve ever made, I know have a five-year period that I need to wait before I can get all my money back and the interests it’s made without taxation. Now, again, the important piece is, they look at it too from a tax year. So, let’s say, we make a contribution in April of 2024 but I do it from my previous year, I haven’t filed my tax return yet and am putting my Roth contribution in, and from my 2023 tax year, even though I am writing the check let’s say on April 15th of 2024, well you get the benefit of basically starting January 1st of 2023. So, that’s when your clock starts. So now you have five years from that January 1st, 2023 time frame, five years from there to get that benefit. What if you can’t wait five years? What if you need to get in there? If you can, try to get in and take the contribution money out because that’s kind of like a return of your own money. It’s just the earnings that would be subject to any taxation and such during that time line of that first five years. Again, other things have to apply as well. Remember, these are retirement accounts for 59 and 1/2, so there’s now an early distribution penalties and such like that. So a few other things that we have to be careful of. But specifically talking about that five-year rule. So again, this is pertaining to the first contribution you make and first Roth IRA you have. Once you make that first IRA contribution, that clock is running and then future contributions you don’t necessarily have to wait that five years. Once you’ve started that clock, fulfilled those five years, you can make contributions all along there. They are looking back to that first one. Conversions are treated a little bit different. So, five-year rule on Roth conversions, meaning I am taking a pre-tax or traditional IRA paying the taxes and converting it to a Roth IRA, conversion. So, they are looked at on a conversion by conversion basis. So, let’s say, I do a $20,000 Roth conversion in 2023, I need to wait right now five years until 2028 to get my full tax benefits for that particular one. Let’s say I do another $20,000 conversion in 2024. Well now I need to wait till 2029 to get the benefits of that one. So, for tax planning purposes and if you’re considering doing some of this or if you trying to do it yourself, just be aware of the timing for that. Why is it important for you? Again, when do you might need the money? We like, when we look at these, usually the benefits there can be some great benefits to Roth conversions. There can be some great benefits to Roth contributions. Again, depending on your specific tax circumstance but again we also have to look at the timing of these and when you may need the money. Now sometimes life events happen and the money is needed in advance and then we need to start looking at how can we extract some of this money on a very specific basis and not pay any taxes or penalties again through looking at the basis of that and such like that. So, Roth IRAs can be a wonderful tool, but like many things, pay attention to the details and some of the things that are out there so it doesn’t trip you up and cause a problem down the road and have any unnecessary taxation you weren’t planning on doing. If this is something you’d like to talk greater about, get into more details or see how Roth conversions or contributions can benefit you, give us a call at the number on the screen for a no-cost, no-obligation and visit one of our team members here at Centennial Wealth Advisory. Until then, keep watching our show. We greatly appreciate the time you spend in this. Check out our YouTube channel and make sure to subscribe to that so you can future notifications of new shows and new content that we put out continuously, trying to make sure that we keep our community educated about retirement planning so you can plan to retire well.