Roth IRA 5 Year Waiting Period
What is the Roth IRA 5 year waiting period?
Does it mean you can't make any penalty-free withdrawals from your Roth IRA in the first five years?
The five year waiting period, in conjunction with reaching age 59 ½, is one of two requirements you must meet before you can withdraw investment gains, rollover funds, and/or conversion funds tax-free and penalty-free.
So it's no true that you have to wait five years before you can withdraw funds from your account.
Remember, Roth IRA principal withdrawals are always tax-free and penalty-free.
It's only when you want to withdraw funds other than your original contributions that you need to know the particulars of the Roth IRA 5 year rule.
Roth IRA 5 Year Waiting Rule
So what exactly is the Roth IRA 5 year waiting period rule?
According to the IRS, you must open and fund your Roth IRA for at least five tax years before you can withdraw investment earnings, rollover funds, and/or conversion funds and avoid Roth IRA penalties and income taxes.
For example, let's say you open and fund your Roth IRA in March 2012.
When is your account in compliance with the Roth IRA 5 year waiting period?
Because in 2017, five tax years have passed - 2012, 2013, 2014, 2015, and 2016.
Once you reach the sixth tax year (2017), you're in compliance with the Roth IRA 5 year waiting period.
And, of course, that begs the question... What's a tax year?
Tax Year vs. Calendar Year
What's the difference between a tax year and a calendar year?
That's important concept to understand.
First, a calendar year is exactly what it sounds like - from January 1st to December 31st of any given year.
But a tax year is different. For instance, you have until April 15th of the following calendar year to file your taxes for the previous calendar year.
This period is known as the tax year.
For example, the Roth IRA deadline for making a contribution in any given year is April 15th of the following year.
As a result, you can make a contribution in one calendar for another tax year.
For instance, you can make a Roth IRA contribution of $5,000 on March 7, 2014 for the 2013 tax year.
So even though you physically made the contribution in the calendar year 2014, your Roth IRA 5 year waiting period begins in the 2013 tax year.
Does that make sense?
5 Year Waiting Period for Conversions
One thing to keep in mind is that the Roth IRA 5 year waiting period applies to each Roth IRA conversion independently.
So even though your account may be in compliance with the five year waiting period, all or part of your rollover and/or conversion fund may not be.
For example, let's say it's 2011, and you're 58 years old with $100,000 in your Roth IRA. It's also worth noting that you opened your account ten years previously.
After talking with your financial advisor, you agree that it's a good idea to convert your Traditional IRA to a Roth IRA. As a result of your conversion, you end up with an additional $50,000 in your Roth IRA.
Four years later in 2015, at the age of 62, you decide to close out your Roth IRA and sail around the world.
Since you're older than age 59 ½, and you've met the requirements of the Roth IRA 5 year waiting period, you should be able to withdraw the entire $150,000 tax-free and penalty-free. Right?
If withdrawn, the conversion funds are subject taxes and penalties because your 2011 conversion has yet to meet the Roth IRA 5 year waiting period requirement.
Remember, you need to wait 5 tax years. In this case, the clock started ticking in 2011.
And while 2015 is the fifth tax year, you don't meet the five year requirement until the sixth tax year.
So, in this case, you need to wait until 2016 before you can withdraw your conversion funds tax-free and penalty-free.
5 Year Waiting Period Exceptions
When it comes to the Roth IRA 5 year waiting period, Roth IRA withdrawal exceptions do exist.
If any of the following situations apply, early withdrawal of your investment gains, rollover funds, and/or conversion funds are NOT subject to the 10% early withdrawal penalty:
1) You die and your beneficiary closes the account.
2) You become disabled according to the definition in IRS Code Section 72(m)(7) and IRS Publication 590.
3) You receive a series of "substantially equal periodic payments" based on your current life expectancy.
4) You use the withdrawn funds to pay qualified higher education expenses for either yourself and/or eligible family members.
5) You use the withdrawn funds to pay for the cost of purchasing a first home (limited to $10,000).
6) You use the withdrawn funds to pay for unreimbursed medical expenses which exceed 7 1/2% of your Adjusted Gross Income (AGI).
7) You use the withdrawn funds to pay for medical insurance premiums after receiving unemployment benefits for more than 12 weeks.
8) You use the withdrawn funds to pay back taxes due to an IRS levy placed against you.
Nevertheless, keep in mind that these exceptions are rare. In most cases, an early Roth IRA withdrawal triggers income taxes and a 10% early withdrawal penalty.
In order to withdraw Roth IRA investment earnings, rollover funds, and conversion funds, you must reach age 59 ½ and your account must comply with the Roth IRA 5 year waiting period.
The five year waiting period states that you must open and fund your account for at least 5 tax years before you can take a qualified distribution from your Roth IRA.
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