The LEARNING library

Roth 5 Year Rules

And do They Apply to My Client?

Clients can ALWAYS take a distribution of basis from Roth IRAS. Basis is annual contributions and converted amounts. Those distributions will not be taxed when they are withdrawn as they were subject to tax when they went into the Roth IRA (or they were already after-tax amounts).

Ordering Rules

There are ordering rules for Roth distributions. All Roth IRAs are treated as one Roth IRA account for purposes of the distribution rules. Contributions come out first. Converted amounts come out next – first in, first out, funds that were taxable at the time of conversion come out before funds that were not taxable at the time of conversion. Earnings come out last.

Qualified Distributions

Distributions must be qualified to be free of all tax and penalties.

Client must have had a Roth IRA (any Roth IRA) for five years,
must be 59 ½
the distribution is due to death,
the distribution is due to the disability of the account owner,
the distribution qualifies for the first time home buyer exception.

The five years start with the establishment of the first Roth IRA and covers all future Roth IRAs that may be established. In other words, it only runs once.

Rule #1 – Applies to all Roth IRAs and determines if distributions of earnings are taxable If a distribution is qualified (see above), all funds come out of the Roth IRA income tax and penalty free.
If the distribution is not qualified, a distribution of earnings (see ordering rules above) will be subject
to income tax and the early distribution penalty, if applicable.

Rule #2 – Applies to all Roth conversions (including conversions from employer plans) If converted amounts are distributed (see ordering rules above) before they have been held for five years AND the account owner is under the age of 59 ½ at the time of the distribution the 10% early distribution penalty will be applied to the amount of the distribution. (If after-tax amounts were converted to the Roth then the distribution of the after-tax amounts will never be subject to the penalty.) This rule applies separately to each conversion. If conversions are done in three different years you have three different five year holding periods to track.