Very few topics in the financial world are as confusing and misunderstood as the two separate 5-year rules for Roth IRA distributions. I’ve seen a handful of articles from reputable sources that contain inaccurate information regarding these rules. This should serve as a reminder that despite the company being well known, these institutions are staffed by humans, who can make mistakes. There is absolutely nothing wrong with asking questions. The same goes for me. I am not an accountant or tax attorney, but have tried to provide numerous citations from qualified sources. When it comes to the financial media and 1-800 customer service centers at financial institutions, trust, but verify.

Roth Recap

In 1997, Senator William Roth of Delaware helped craft what became Public Law 105-34, known as the Taxpayer Relief Act of 1997. Section 302 called for the establishment of a new, “non-deductible tax-free individual retirement account.” With the President’s signature on August 5, 1997, the Roth IRA was born.

When you hear the term “Roth”, don’t think of it as an investment, but instead as a tax wrapper for your investments. You can invest in an S&P 500 index fund in a pre-tax/traditional IRA and a post-tax/Roth IRA. You can invest in an S&P 500 index fund in a pre-tax/traditional employer sponsored retirement plan like the federal Thrift Savings Plan (TSP) or a private sector 401(k). You can also invest in an S&P 500 index fund in a post-tax/Roth employer sponsored retirement plan. The investment stays the same – an S&P 500 index fund – the difference is the tax wrapper around the investment (Roth vs. traditional).

Traditional IRA (pre-tax)

(1) You may* be able to deduct your contribution (reducing your taxable income)

(2) The money grows tax-deferred

(3) Distributions are taxed as ordinary income. You must generally wait until age 59 ½ to withdraw funds without a 10% penalty. There are many exceptions to this 10% penalty.

This pre-tax/traditional money grew without ever being taxed, so at some point you, or your heirs, will have to pay tax on it.

*Note: Your ability to deduct traditional IRA contributions depends on, (1) your income and (2) whether you and/or your spouse are covered by a workplace retirement plan. This income + workplace coverage test for deductibility does not apply to workplace plans like your traditional TSP. When you make a traditional TSP contribution, your taxable income is reduced.

Roth IRA (post-tax)

(1) You pay tax on the money you contribute (no tax deduction)

(2) The money grows tax-free

(3) Qualified distributions are tax-free…if you play by the rules. What rules? That's what we'll be covering with these two 5-year rules.

Roth IRA vs. Roth TSP

Please note, this article is about the rules for Roth IRA distributions. There are differences between a Roth IRA and a Roth employer sponsored retirement plan like a Roth TSP, Roth 401(k), Roth 403(b), and Roth 457.

There ARE income limits for direct Roth IRA contributions.

There ARE NOT income limits for Roth TSP contributions.

You CAN contribute to BOTH a Roth TSP and Roth IRA (subject to income limits) in the same year.

2025 Contribution Limits

In 2025, you can contribute $7,000 (+ $1,000 catch-up for those who will turn age 50) to a Roth IRA.

In 2025, you can contribute $23,500 (+$7,500 catch-up for those who will turn age 50, or + $11,250 catch-up for those who will turn age 60, 61, 62, or 63) to a Roth TSP.

Too Long Don't Read - Summary of both 5-Year rules

If you can only take-away one piece of information from this article, remember this:

5-Year Rule # 1 / 5-Year Forever Rule

Only determines if EARNINGS are subject to

ordinary income TAX when distributed from a Roth IRA. If you withdraw EARNINGS after the 5-year period, starting January 1 of the year you funded your very first Roth IRA, you have satisfied 5-Year Rule # 1.

This only has to be satisfied once in your life. Satisfying 5-Year Rule # 1 does NOT automatically mean your distribution is tax & penalty free. 5-Year Rule #1 is half of a two-prong test to determine if the distribution is tax & penalty free, otherwise known as "qualified".

5-Year Rule # 2 / 5-Year Conversion Rule

Only determines if a 10% PENALTY (“additional tax”) applies to

TAXABLE CONVERTED PRINCIPAL when distributed from a Roth IRA. If you withdraw taxable converted principal after the 5-year period, starting January 1 of the year you did the conversion, you have satisfied 5-Year Rule # 2 for that conversion. Each conversion has its own separate 5-year period.

5-Year Rule # 2 has nothing to do with "qualified" tax & penalty free earnings - that's 5-Year Rule # 1.

3 Foundations – Contributions, Ordering Rules, & Aggregation

Before diving into the two 5-year rules, we need to cover three important factors that will help build the necessary knowledge foundation to really understand these rules. Without these three things, the rules won’t make sense.

Foundation # 1: Withdrawal of Roth IRA Contributions

Roth IRA contributions (“basis”) can be withdrawn at any age, for any reason, without tax or penalty. Full stop. There is NO 5-year rule of any type when it comes to withdrawing your own Roth IRA contributions.

“A distribution from a Roth IRA is not includible in the owner's gross income if it is a qualified distribution or to the extent that it is a return of the owner's contributions to the Roth IRA.”

Source: A-1(b) of 26 CFR § 1.408A-6

“The 10-percent additional tax under section 72(t) will apply (unless the distribution is excepted under section 72(t)) to any distribution from a Roth IRA includible in gross income.”

Source: A-5(a) of 26 CFR § 1.408A-6

“Basis” – For our purposes, when you see the term “basis”, just think of that as your contributions to the Roth IRA. Earnings/growth on your investment is NOT basis.

Source: IRS - Is the distribution from my Roth account taxable?

Foundation # 2: Ordering Rules

As mentioned in IRS Publication 590-B and in A-8 of 26 CFR § 1.408A-6, when you withdraw money from a Roth IRA, money comes out in this order:

(1) From regular contributions

(2) From conversions and rollover contributions (first-in-first-out)

(a) Taxable portion first, then

(b) Non-taxable portion

(3) From earnings.

You don’t start withdrawing earnings until you’ve depleted the conversion bucket. You don’t start withdrawing conversions until you’ve depleted the contribution bucket.

In the above example, we’ll say that a 35-year-old Roth IRA owner contributed $39,000 from 2024-2028. In 2029, this individual, who is under age 59 ½, decides to withdraw $20,000 for any reason. They can withdraw $20,000 without tax or penalty, even though they’re under age 59 ½. Why? The ordering rules. The first money pulled from the Roth IRA bucket is made up of contributions.

Ordering Rules Do Not Apply to Roth TSP

Whether you choose to withdraw only from your Roth TSP, or pro rata, meaning your distribution consists of portions from both your traditional TSP and Roth TSP balance, the distribution will contain a portion of Roth contributions and Roth earnings. You cannot withdraw just your Roth TSP contributions.

Source: Page 2 of TSP BK26. — Source: Page 2 of **TSP BK26**.

You can see in the above example, this individual’s TSP has a total balance of $100,000. $60,000 traditional TSP, $15,000 Roth TSP contributions, and $25,000 Roth earnings. If they were to take a "pro rata" / proportionate distribution of $1,000, 60% would be taxed as ordinary income ($600), 15% would not be taxed since it represents a return of Roth contributions that were already taxed ($150), and 25% representing Roth earnings would be taxed as ordinary income ($250).

Why was the $250 Roth earnings portion taxed? Isn’t the whole point that the Roth is tax-free? In this example from page 2 of TSP BK26 – the individual is 57-years-old. They took a distribution before turning age 59 ½, which means the Roth earnings are non-qualified and therefore are taxable.

So, how do these earnings become “qualified”? This is why you need to understand 5-Year Rule # 1.

Foundation # 3: IRA Aggregation

The IRS views ALL of your IRAs as one giant bucket. It does not matter how many IRAs you have, or at which custodians (Vanguard, Fidelity, Schwab, etc.). The annual contribution limit for IRA contributions is the maximum amount you can contribute across ALL of your IRAs that year, regardless of whether you are putting money in multiple traditional IRAs or Roth IRAs. Note: inherited IRAs are not included in your total IRA bucket. Also, rollovers and conversions do not count against the annual contribution limit.

“All individual retirement plans shall be treated as 1 contract.” Source: 26 U.S. Code § 408(d)(2)(A).

“All regular contributions made for the same taxable year to all the individual's Roth IRAs are aggregated and added to the undistributed total regular contributions for prior taxable years. Regular contributions for a taxable year include contributions made in the following taxable year that are identified as made for the taxable year.”

Source: A-9(b) of 26 CFR § 1.408A-6

So, now that we know: (1) Contributions come out tax and penalty free, (2) the ordering rules, and (3) aggregation, let’s look at an example.

As you make contributions, they are added to prior years’ contributions that you haven’t withdrawn. As you build up your contributions, the amount you can distribute tax and penalty free also builds up (orange).

You’ll see in the example above, from 2024-2028, $29,000 was contributed to all of the Roth IRAs; this means $29,000 could be withdrawn tax and penalty free. In 2029, $5,000 is withdrawn from the Vanguard Roth IRA which reduces the total contributions that can be withdrawn by $5,000 (down to $24,000). In 2030, an additional $3,000 is withdrawn from the Vanguard Roth IRA, but $5,000 is contributed towards the Schwab Roth IRA. The net effect is $2,000 added to the contribution bucket, resulting in $26,000 total Roth IRA contributions that can be withdrawn tax & penalty free at the end of 2030.

What happens if you withdraw all of the contributions? Isn’t the growth in that account (the earnings) also tax-free when distributed? Isn’t that the whole idea of this golden Roth IRA? Yes! However, that brings us to 5-Year Rule # 1, what many call the 5-Year Forever rule because you only have to satisfy it once in your lifetime. Satisfy this rule once, and you’re good to go...forever.

5-Year Rule # 1 / 5-Year Forever Rule

This rule only determines if EARNINGS are subject to ordinary INCOME TAX when distributed from a Roth IRA.

To start, we have to first look at the two requirements for a Qualified Roth IRA Distribution (QD). Qualified distributions are tax and penalty free. To meet the QD test, you must satisfy both prongs of a two-prong test.

Prong # 1: “It is made after the 5-year period beginning with the first tax year for which a contribution was made to a Roth IRA set up for your benefit.”

Translation – Your very first contribution (or first conversion if your very first Roth IRA is opened to execute a conversion) to ANY Roth IRA was at least 5 tax years ago. Remember, the IRS views all of your Roth IRAs as one. The clock starts January 1st of the tax year you made the contribution for. So, if you make a $1 contribution to a Roth IRA on December 31, 2024, your 5-year clock starts January 1, 2024. Source: A-2 of 26 CFR § 1.408A-6.

Don’t forget, you can contribute to your Roth IRA up until the tax filing deadline for that year. So, let’s say the tax filing deadline for tax year 2024 is April 15, 2025. If you make your very first $1 contribution to a Roth IRA on April 15, 2025, but it’s a contribution for tax year 2024, your 5-Year Forever clock starts January 1, 2024, even though you contributed April 15, 2025. So, the 5-year clock in this scenario is more like a 3-year 8-month clock (4/15/2025 – 1/1/2029).

Source: A-2 of 26 CFR § 1.408A-6.

Prong # 2: The payment or distribution is made:

A. On or after the date you reach age 59 ½, OR

B. While you are disabled, OR

C. To a beneficiary or to your estate after your death, OR

D. In accordance with the requirements listed under the first-time homebuyer exception – up to a lifetime limit of $10,000 per tax filer.

That’s it.

There is no need to add any additional layers or confusion to this. If you satisfy the two-prong test outlined above, BOTH # 1 and # 2 (EITHER a, b, c or d), your Roth IRA distributions are tax and penalty free. End of story.

It does not matter how the money got into your Roth IRA – direct contribution, “backdoor” method/non-taxable conversion, taxable conversion, rollover, traditional 401(k)/TSP to Roth IRA conversion…it does not matter. Satisfy # 1 and any part of # 2, and your distribution is penalty free and not “includible in gross income”.

Source: 26 U.S. Code § 408A(d)(1)

Here are additional sources to back this up.

Source: What Are Qualified Distributions, IRS Publication 590-B

“(A) In general, the term “qualified distribution” means any payment or distribution— (i) made on or after the date on which the individual attains age 59½, (ii) made to a beneficiary (or to the estate of the individual) on or after the death of the individual, (iii) attributable to the individual’s being disabled, or (iv) which is a qualified special purpose distribution. (B) A payment or distribution from a Roth IRA shall not be treated as a qualified distribution under subparagraph (A) if such payment or distribution is made within the 5-taxable year period beginning with the first taxable year for which the individual made a contribution to a Roth IRA.” Source: 26 USC § 408A(d)(2)

What is a qualified special purpose distribution mentioned above?

26 USC § 408A(d)(5) points us to 26 U.S. Code § 72(t)(2)(f) – “Distributions to an individual from an individual retirement plan which are qualified first-time homebuyer distributions.” There is a $10,000 lifetime limit – more details here.

Source: IRS Publication 590-B — Source: **IRS Publication 590-B**

What If You Only Satisfy Prong # 1?

If you DID first contribute to a Roth IRA at least 5 tax years ago, but DO NOT meet any of the elements of prong # 2, your distribution is non-qualified. Therefore, earnings will be subject to ordinary income tax and may also be subject to a 10% penalty. The penalty may not apply if another exception exists.

What If You Only Satisfy Prong # 2?

If you meet one of the elements under prong # 2, you may be able to avoid the 10% penalty, but the 5-Year Forever rule still applies, which means earnings would still be taxable as part of the non-qualified distribution.

So, if you’re dead, disabled, over 59 ½, or withdrawing under the qualified first-time homebuyer distribution rules, but you did NOT have your very first Roth IRA funded at least 5-years ago, the earnings will still be taxable. Avoiding the 10% penalty does not guarantee avoiding income tax.

For those wondering, yes, the 5-Year Forever rule even survives death. Let’s say you fund your very first Roth IRA at age 50 in 2025 and tragically die at age 52 in 2027. Your Roth IRA will pass to your beneficiary. If your beneficiary distributes earnings before January 1, 2030, the EARNINGS will be taxable, but there will be NO 10% early-withdrawal penalty (regardless of your beneficiary’s age) because death is an exception to the 10% penalty.

What if you’re 57 and fund your very first Roth IRA? At age 59 ½ can you withdraw tax and penalty free? Contributions – yes. Earnings – NO. In this scenario, you could withdraw earnings and avoid the 10% early withdrawal penalty since you’re over age 59 ½, but you would not avoid tax on the earnings portion. But wait, isn’t age 59 ½ the magic hurdle to cross? For prong # 2 yes, but remember, you haven’t yet satisfied prong # 1, which is why I suggest contributing something to a Roth IRA as soon as possible to start the 5-year clock for the 5-Year Forever rule.

Are “Qualified Distributions” the Same for Employer Plans Like a Roth TSP?

For employer plans like a Roth TSP, a “qualified distribution” requires the same two things listed above. The only difference is that under Prong # 2, you cannot withdraw money from an employer plan under the first-time homebuyer exception and have it count as a qualified distribution. The first-time homebuyer exception only applies to Roth IRAs.

Why is this important?

It means the “Rule of 55”, which allows regular FERS employees to withdraw money from their TSP penalty-free when they separate from service in the year they turn 55 or older, DOES NOT APPLY to the Roth TSP. FERS Special Category Employees (SCE), also known as Qualified Public Safety Employees (QPSE) can withdraw traditional TSP funds without the 10% penalty at age 50 (when they have completed 20 years of service as a SCE/QPSE), or at any age when they have completed 25-years of service as a SCE/QPSE, but NOT from their Roth TSP.

Two things to note with the “Rule of 55/50”: (1) These exceptions only apply to employer plans, not IRAs. If you transfer/rollover your TSP to an IRA, the age + service free pass from the 10% penalty goes away. (2) The exception only applies to the plan (TSP, 401(k), 403(b), etc.) of the employer you are separating from. You cannot use the “Rule of 55/50” to get penalty-free access to an old 401(k) from a job you had in your 20’s. Possible solution: Roll the old 401(k) into the TSP if you want penalty free access.

How Do You Get Roth TSP Earnings Tax & Penalty Free?

The earnings portion of your Roth TSP becomes available tax and penalty free (“qualified”) once you’ve satisfied 5-Year Rule # 1 (first funded your Roth TSP 5 -years ago) and you’re either 59 ½, disabled, or dead.

Straight from the source.

What 5-Year Period Do You Use if You Rollover a Roth TSP into a Roth IRA?

The Roth IRA clock is what counts. Your Roth TSP time does not transfer to your Roth IRA.

Source: Page 6 of TSP BK26. — Source: Page 6 of **TSP BK26**.

But what if you had a Roth TSP for 5-years, doesn’t that 5-year “seasoning” transfer to the Roth IRA and satisfy 5-Year Rule # 1 for the Roth TSP money? No – once you move the money from your Roth TSP to a Roth IRA, it does not matter how long it’s been since you first funded your Roth TSP.

If you retire at age 60, open your very first Roth IRA (you never previously funded any Roth IRA in your entire life), transfer your Roth TSP into your Roth IRA, and make withdrawals from that Roth IRA, you will be taxed on earnings because the distribution will not be "qualified".

Why? You didn’t satisfy QD prong # 1, the 5-Year Forever rule for the Roth IRA.

What if you had a Roth IRA for 5-years, but only had your Roth TSP for 1-year, will a transfer from your Roth TSP into your Roth IRA taint and eliminate the 5-years you already satisfied in your Roth IRA? No.

Here are additional sources to back this up.

“When you roll over a distribution from a designated Roth account to a Roth IRA, the period that the rolled-over funds were in the designated Roth account does not count toward the 5-taxable-year period for determining qualified distributions from the Roth IRA. However, if you had contributed to any Roth IRA in a prior year, the 5-taxable-year period for determining qualified distributions from a Roth IRA is measured from the earlier contribution. So, if the earlier contribution was made more than 5 years ago and you are over 59 ½ a distribution of amounts attributable to a rollover contribution from a designated Roth account would be a qualified distribution from the Roth IRA.”

Source: IRS - Retirement Plans FAQs on Designated Roth Accounts

“Q-4. In the case of a rollover from a designated Roth account to a Roth IRA, when does the 5-taxable-year period for determining qualified distributions from a Roth IRA begin?”

“A-4. The 5-taxable-year period for determining a qualified distribution from a Roth IRA begins with the earlier of the taxable year described in A-2 of § 1.408A-6 or the taxable year in which a rollover contribution from a designated Roth account is made to a Roth IRA.” A-2 of § 1.408A-6 states: “The 5-taxable-year period described in A-1 of this section begins on the first day of the individual's taxable year for which the first regular contribution is made to any Roth IRA.”

Source: Q-4 & A-4 of 26 CFR § 1.408A-10

“The 5-taxable-year period described in A-1 of this section begins on the first day of the individual's taxable year for which the first regular contribution is made to any Roth IRA of the individual or, if earlier, the first day of the individual's taxable year in which the first conversion contribution is made to any Roth IRA of the individual.”

Source: A-2 of 26 CFR § 1.408A-6

What If You Have Multiple Employer Plans – Which 5-Year Period Applies?

Some of you have worked for multiple employers and may have several Roth employer sponsored retirement plans. Unfortunately, employer Roth plans each have their own separate 5-year holding period. If you have an old Roth 401(k), a Roth 403(b), and a Roth TSP – they each have their own 5-year rule that must be satisfied. However, if you transfer/rollover one of these designated Roth accounts into another designated Roth account, the earlier holding period will apply. As stated above, if you roll one of these Roth employer plans into your Roth IRA, the Roth IRA 5-year rule applies.

“If you make a direct rollover from a designated Roth account under another plan, the 5-taxable-year period for the recipient plan begins on the first day of the taxable year that you made designated Roth contributions to the other plan, if earlier.”

Source: IRS - Retirement plans FAQs on designated Roth accounts

“5-year holding period for qualified distributions: Designated Roth Account: Separate for each Roth account and begins on January 1 of the year contributions made to that account. If one Roth account is rolled into another, the earlier start date applies.”

Source: IRS – Ten differences between a Roth IRA and a designated Roth account

“If an employee has elective deferrals made to designated Roth accounts under two or more plans, the employee may have two or more different 5-taxable-year periods of participation. However, if a direct rollover contribution of a distribution from a designated Roth account under another plan is made by the employee to the plan, the 5-taxable-year period of participation begins on the first day of the employee's taxable year in which the employee first had designated Roth contributions made to such other designated Roth account, if earlier than the first taxable year in which a designated Roth contribution is made to the plan.”

Source: A-4(b) of 26 CFR § 1.402A-1

If You Transfer / Rollover a Roth TSP into a Roth IRA, Can You Withdraw Roth TSP Contributions Tax & Penalty Free?

Yes – but there are two versions of this scenario.

Scenario # 1: Transfer / Rollover from Roth TSP (NON-QUALIFIED) to Roth IRA

This would apply if you’re either younger than 59 ½ and/or you haven’t had your Roth TSP for at least 5 tax years. You have not satisfied the two-prong test to make your distributions qualified.

In this scenario, the characteristics of your dollars within the Roth TSP transfer to the Roth IRA. If your $70,000 Roth TSP consisted of $50,000 worth of Roth contributions and $20,000 worth of earnings growth, upon transferring this to your Roth IRA, you would have $50,000 basis/contributions (which can be withdrawn tax and penalty free) and $20,000 earnings added to your Roth IRA. Remember, the earnings portion would be subject to the two-prong test of “qualified” distributions.

Scenario # 2: Transfer / Rollover from Roth TSP (QUALIFIED) to Roth IRA

This would apply if you are 59 ½ and have had your Roth TSP for at least 5 tax years. In this scenario, all of your dollars (contributions and earnings) are eligible for tax and penalty free withdrawal and would land in your Roth IRA as basis, meaning you could withdraw that amount tax and penalty free as if it were a regular Roth IRA contribution.

However, there could be a catch in this qualified TSP scenario if you have not satisfied 5-Year Rule # 1 / 5-Year Forever rule, with any Roth IRA.

Let’s say you have $100,000 in your TSP. $40,000 worth of contributions and $60,000 from earnings.

(1) You are over 59 ½, and

(2) First funded your Roth TSP at least 5 tax years ago

Good news! You can take qualified distributions. You can take the entire $100,000, roll it into your Roth IRA, and it’ll be treated as basis. This $100,000 can be withdrawn completely tax and penalty free.

However, if this is the very first Roth IRA you’ve ever had in your life, any subsequent earnings that grow on top of that $100,000 are subject to 5-Year Rule # 1 / 5-Year Forever rule in order to come out tax-free. Remember, no 10% penalty would apply since you’re over age 59 ½, but earnings on top of that $100,000 would still be subject to the two-prong test of “qualified” distributions. You’d have to wait 5-years to distribute any growth on top of that $100,000 and have it be tax free.

“Q-3. For purposes of the ordering rules on distributions from Roth IRAs, what portion of a distribution from a rollover contribution from a designated Roth account is treated as contributions?”

“A-3. (a) …the amount of a rollover contribution that is treated as a regular contribution is the portion of the distribution that is treated as investment in the contract under A-6 of § 1.402A-1 and the remainder of the rollover contribution is treated as earnings. Thus, the entire amount of any qualified distribution from a designated Roth account that is rolled over into a Roth IRA is treated as a regular contribution to the Roth IRA. Accordingly, a subsequent distribution from the Roth IRA in the amount of that rollover contribution is not includible in gross income under the rules of A-8 of § 1.408A-6.” Source: Q-3 & A-3 of 26 CFR § 1.408A-10

“A-6. (a) If a distribution from a designated Roth account is rolled over to another designated Roth account in a direct rollover, the amount of the rollover contribution allocated to investment in the contract in the recipient designated Roth account is the amount that would not have been includible in gross income if the distribution had not been rolled over. Thus, if an amount that is a qualified distribution is rolled over, the entire amount of the rollover contribution is allocated to investment in the contract.

Source: Q-6/A-6 of 26 CFR § 1.402A-1

“Investment in the Contract” – For our purposes, when you see the term “investment in the contract”, just think of that as your contributions to a Roth TSP. Earnings/growth on your investment is NOT investment in the contract. This is similar to when we talk about “basis” in your Roth IRA.

Source: Q-7/A-7(b) of 26 CFR § 1.402A-1

Don’t forget the TSP withdrawal rules

You cannot do a rollover from your Roth TSP to your Roth IRA while still working and under age 59 ½. See rollover details and TSP BK12 covering in-service (still working) withdrawals to include hardship and age 59 ½.

Source: TSP Fact Sheet — Source: **TSP Fact Sheet**

5-Year Rule # 2 / 5-Year Conversion Rule

This 5-year rule only determines if you’ll pay a 10% penalty/additional tax on taxable converted amounts. This 5-year rule ONLY applies to those under age 59 ½. If you’re over age 59 ½, you can erase the idea of a 10% Roth IRA penalty from your brain (tax may still apply to earnings if you didn’t satisfy the 5-Year Forever rule).

If you convert traditional (pre-tax) money to a Roth IRA, and you’re under age 59 ½, you cannot withdraw those TAXABLE CONVERTED dollars without paying a 10% additional tax/penalty on the taxable converted amount until 5 tax years have passed (unless another 72(t) exception applies).

Source: A-5(b) of 26 CFR § 1.408A-6

Just like with the 5-Year Forever rule, the 5-Year Conversion clock starts January 1st of the year you do the conversion.

IMPORTANT: Each individual taxable conversion has its own separate 5-year clock.

Here’s an example.

2024

You’re under age 59 ½ and you convert $10,000 from a traditional IRA to a Roth IRA (this is your first Roth IRA ever). This conversion is a taxable event and you’ll have to pay ordinary income tax on that $10,000. The 5-year clock begins January 1, 2024, regardless of what day in 2024 you did the conversion.

2025

The $10,000 has grown to $10,500. If you withdraw $10,000 before satisfying the 5-Year Conversion rule, you’ll owe a 10% penalty on this $10,000. You will not owe any income tax on the $10,000 because you already paid tax when it was converted. If you withdrew all $10,500, you would owe the 10% tax on the original $10,000 you converted, and you would owe ordinary income tax and a 10% penalty (if no other exception applies) on the $500 earnings/growth because you did not satisfy the two-prong test to make this a qualified distribution of earnings (5-Year Rule # 1 / 5-Year Forever rule (+) age 59 ½, disabled, dead, or first-time homebuyer).

Let’s change one thing and say this isn’t your first Roth IRA – what if you made prior year contributions worth at least $10,500 – in that case, you could withdraw $10,500 tax & penalty free. How? The ordering rules. Don’t forget, contributions always come out first (tax & penalty free, at any time, for any reason).

“If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA…you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions.” “You must generally pay the 10% additional tax on any amount attributable to the part of the amount converted that you had to include in income (recapture amount).”

Source: IRS Publication 590-B

“The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion is separately determined for EACH CONVERSION, and isn’t necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution.” This is the IRS telling us that there is a 5-Year Forever rule and a 5-Year Conversion rule.

Source: IRS Publication 590-B

“The 10-percent additional tax under section 72(t) also applies to a nonqualified distribution, even if it is not then includible in gross income, to the extent it is allocable to a conversion contribution, if the distribution is made within the 5-taxable-year period beginning with the first day of the individual's taxable year in which the conversion contribution was made…For purposes of applying the tax, only the amount of the conversion contribution includible in gross income as a result of the conversion is taken into account.”

Source: A-5(b) of 26 CFR § 1.408A-6 / 26 U.S. Code § 408A(d)(3)(f)

Again, the 5-Year Conversion rule does not apply to those over age 59 ½.

“Unless one of the exceptions listed later applies, you must pay the additional tax on the portion of the distribution attributable to the part of the conversion or rollover contribution that you had to include in income because of the conversion or rollover. Exceptions. You may not have to pay the 10% additional tax in the following situations. You have reached age 59 ½.”

Source: IRS Publication 590-B

What If You Use Part of the Conversion to Pay the Tax?

When you convert pre-tax money from a traditional IRA (the traditional IRA contribution was previously deducted) to a Roth IRA, that is a taxable event. You got a tax break/deduction for that traditional IRA contribution, and you are now turning those pre-tax dollars into tax-free dollars. There’s a tax toll required on that journey.

Where people can make a mistake is by using part of the converted amount to pay the tax.

Here’s how the mistake would look:

(1) You’re under age 59 ½

(2) You convert $10,000 from your traditional IRA to your Roth IRA

(3) When you do the conversion, your custodian (Vanguard, Fidelity, Schwab, etc.) asks you if you want to withhold taxes

(4) You tell them to withhold 20% tax from the conversion

(5) $2,000 (20% of $10,000) goes to the IRS and $8,000 is converted to your Roth IRA

You’ll pay ordinary income tax on that $8,000 converted amount that lands in your Roth IRA and you’ll pay ordinary income tax on the $2,000 amount withheld for taxes.

Here’s the issue: That $2,000 you withheld for taxes counts as a distribution. So, because you’re under 59 ½ and “distributed” $2,000 from your IRA (non-qualified), not only will you pay income tax on that $2,000, you’ll have to pay a 10% penalty. You’ll receive a 1099-R from the custodian and in Box 1 (Gross Distribution), the amount withheld for taxes will be included in that gross amount.

“Box 1. Gross Distribution: Enter the total amount of the distribution before income tax or other deductions were withheld.” Source: IRS Instructions for Form 1099-R

Source: Ed Slott and Company, LLC – How to Use Income Tax Withholding on IRA Distributions, and When Not To

Who Really Needs to Know This 5-Year Conversion Rule?

For the vast majority of traditional retirement savers, the 5-year rules won’t come into play. Even if you withdraw some money prior to age 59 ½, it’s most likely made up of Roth contributions.

Generally, the 5-Year Conversion rule is important for those who are under age 59 ½ and plan to use a “Roth Conversion Ladder” to get access to their money prior to age 59 ½ without penalty. Remember, the rules are in place to prevent certain behavior. The government doesn’t want people under age 59 ½ converting their pre-tax retirement accounts and immediately withdrawing that amount penalty free. Hence the separate 5-year clock for each and every conversion.

Let’s say you plan to retire at age 50. You’ll have enough money to sustain you until age 55, but once you turn 55, you’re going to need to withdraw some money from your pre-tax retirement accounts. If no other exception applies, you would have to pay ordinary income tax and a 10% early withdrawal penalty on this pre-tax money since you’ll be under age 59 ½.

You know that you’ll have to pay tax on your pre-tax retirement money either way, due to the fact that it’s been growing tax-deferred, but you don’t want to pay a 10% penalty. How can you get access to this retirement money at age 55 without a penalty?

You could use what’s known as a “Roth Conversion Ladder”. To avoid the 10% penalty at age 55, you would want to start building the ladder at age 50.

In the scenario above, in 2024 at age 50, $10,000 is converted from your traditional IRA to your Roth IRA. You’ll pay ordinary income tax on this $10,000 conversion for tax year 2024. This $10,000 has now been taxed and is moved into your Roth IRA bucket. The 5-year conversion clock starts January 1, 2024.

After January 1, 2029, you can withdraw this $10,000 converted amount without tax or penalty. How?

(1) You already paid tax on this $10,000.

(2) You waited 5 tax years and satisfied 5-Year Rule # 2 / 5-Year Conversion rule.

You’ll see the Roth Conversion Ladder concept is similar to a bond or CD ladder, where different amounts mature as the money is needed. You need to convert 5 tax years ahead of when you need access to that converted money penalty free.

Note: Earnings/growth associated with the converted amount cannot be withdrawn tax and penalty free even after 5-years (until you reach age 59 1/2). Why? Remember, EARNINGS within a Roth IRA are only “qualified” if they satisfy the two-prong test – (1) 5-year Rule # 1 / 5-Year Forever rule and (2) age 59 ½, or disabled, or dead, or first-time homebuyer.

Does the 5-Year Conversion Rule Apply to Non-Taxable “Backdoor” Roth Contributions / Conversions

No – and here’s why. When you make a “backdoor” Roth IRA contribution, you are (1) making a non-deductible contribution to a traditional IRA and then (2) converting that money to a Roth IRA. You already paid tax on these dollars.

The 5-Year Conversion rule does not apply to NON-TAXABLE converted amounts.

If you make a NON-DEDUCTIBLE contribution of $7,000 from your bank account to a traditional IRA, and then convert those $7,000 post-tax dollars from your traditional IRA to your Roth IRA – that “backdoor” event is recorded on your tax return via IRS Form 8606.

Nowhere on your tax return does this $7,000 show up as additional income due to the conversion. Therefore, we have a non-taxable conversion. Note: This example assumes you have no other traditional (pre-tax) IRAs, SIMPLE, or SEP IRAs. If you did have these other accounts, you would be subject to the pro rata rule, meaning only a prorated amount of the conversion would be non-taxable.

When determining the amount of “additional tax” / 10% penalty you have to pay on an early distribution, the IRS points us to the “recapture amount”. Let’s take a look at the instructions for IRS Form 5329.

“If you converted or rolled over an amount to your Roth IRAs in 2020 through 2024 and you received an early distribution for 2024, the recapture amount you must include on line 1 is the amount, if any, of the early distribution allocated to the TAXABLE portion of your 2020 through 2024 conversions or rollovers.

Generally, an early distribution is allocated to your Roth IRA contributions first, then to your conversions and rollovers on a first-in, first-out basis. For each conversion or rollover, you must first allocate the early distribution to the portion that was SUBJECT TO TAX in the year of the conversion or rollover, and then to the portion that wasn’t subject to tax. The recapture amount is the sum of the early distribution amounts that you allocate to these TAXABLE portions of your conversions or rollovers.”

“You must generally pay the 10% additional tax on any amount attributable to the part of the amount converted that you had to INCLUDE IN INCOME (recapture amount).”

Source: IRS Publication 590-B

For purposes of applying the tax, only the amount of the conversion contribution INCLUDIBLE IN GROSS INCOME as a result of the conversion is taken into account.”

Source: A-5(b) of 26 CFR § 1.408A-6

A-8. (a) Any amount distributed from an individual's Roth IRA is treated as made in the following order –

(1) From regular contributions;

(2) From conversion contributions, on a first-in-first-out basis; and

(3) From earnings.

A8. (b) To the extent a distribution is treated as made from a particular conversion contribution, it is treated as made first from the portion, if any, that was INCLUDIBLE in gross income as a result of the conversion.

Source: A-8 of 26 CFR § 1.408A-6

“Yes, there is a 5-year clock before converted pre-tax dollars are available for withdrawal penalty-free for anyone under age 59½. However, AFTER-TAX DOLLARS that are CONVERTED are NEVER subject to the 10% penalty, regardless of when they are withdrawn.”

Source: Ed Slott and Company, LLC – Backdoor Roth Conversions and IRA Losses

“Basically, it says that you don’t have to pay penalties on the part you DID NOT INCLUDE in INCOME on the conversion.”

Source: Pure Financial Advisors, Your Money Your Wealth Podcast # 518 – Can Backdoor Roth Conversions Be Withdrawn at Any Time?

Pretty simple so far. Non-deductible/post-tax dollars that are converted via “backdoor” method from a traditional IRA to a Roth IRA are NOT subject to a 5-year waiting period.

HOWEVER, don’t forget the ordering rules when thinking through this.

Here’s how you could easily end up with a mix of pre-tax converted amounts and post-tax converted amounts.

Sometimes, when executing a “backdoor” Roth IRA contribution, some earnings growth will accumulate before the conversion is executed. For example, let’s say you made a $7,000 non-deductible contribution to a traditional IRA. The $7,000 sat in a money market settlement fund for a few days and earned interest, resulting in a new balance of $7,001. Most people will simply convert the entire $7,001 ($7,000 post-tax contribution + $1 pre-tax growth), resulting in $7,001 landing in the Roth IRA. That $1 worth of earnings will count as taxable income for the year of the conversion. Not a big deal.

If you then withdrew $7,000 from your Roth IRA, and had never made contributions or did conversions prior to this $7,001 “backdoor” contribution, you would not be pulling the $7,000 non-taxable converted amount first. The ordering rules tell us that taxable converted amounts (in this example, the $1 included in gross income in the year of conversion) is distributed before non-taxable converted amounts. This $1 taxable converted amount would be subject to its own 5-Year Conversion rule. Why? Because that $1 was converted and it was INCLUDED in TAXABLE INCOME, therefore, it has a 5-Year Conversion clock attached to it. Again, not the end the world.

So, if you distributed $7,000 (and had no prior contributions or prior taxable conversions), you’d actually be distributing:

-$1 taxable converted dollar, which would be subject to a 10% penalty if distributed within 5 tax years, but not income tax because you already paid tax at the time of conversion, and

-$6,999 non-taxable converted dollars, which would not be subject to ordinary income tax or a 10% penalty because the money was already taxed and was not included in gross income when you did the conversion.

Sean Mullaney, CPA, calls this $1 the “Micro Layer” in Example 5 under the Application to Fact Patterns section in his article, The Taxation of Roth IRA Distributions.

Final Thoughts

There tends to be a lot of questions and back-and-forth on the two 5-year rules. I personally think it’s overblown. For most people, the rules aren’t going to be a factor at all. Remember, you should avoid dipping into your Roth bucket prior to age 59 ½ at all costs. Let time do its thing and take advantage of tax-free compounding growth.

Everyone, regardless of age

Get at least $1 into a Roth IRA to start the “5-Year Forever” clock.

Over age 59 ½

If you’ve contributed to any Roth IRA at least 5 tax years ago, that takes care of 5-year rule # 1 / 5-Year Forever rule. What about 5-year rule # 2 for taxable converted amounts? This doesn’t apply to you because you’re over age 59 ½. You no longer have to ever worry about the 5-Year Conversion rule again.

Under age 59 ½

I’ll stress this again, you should really avoid touching any Roth money, especially when you have decades to let it compound tax-free. If you absolutely need to withdraw from your Roth IRA, you’re hopefully only tapping into contributions / basis, which can be withdrawn at any time for any reason without tax or penalty. Keep track of your contributions and make sure you’re filing IRS Form 8606 for all “backdoor” contributions/conversions. If the IRS sends you a notice saying that you owe them tax or penalty for an early Roth IRA distribution, you’ll want to have proof to show them you withdrew from the contributions bucket only. Your annual Form 5498 issued by the custodian can help support contribution tracking.

About the Author

Tyler Weerden is a fee-only financial planner and the owner of Layered Financial, a Registered Investment Advisory firm based in Arlington, Virginia. In addition to being a financial planner, Tyler is a full-time federal agent. He holds a Bachelor of Science degree, a Master of Science degree, passed the Series 65 exam, and is a Certified Fraud Examiner (CFE). Tyler is the sole Investment Adviser Representative at Layered Financial.

Prior to becoming a federal agent, Tyler served as a state trooper, local police officer, and was a member of the U.S. Army National Guard. He has served in both domestic and overseas Foreign Service assignments. Tyler has experience with local, state, and federal pension systems, 457(b) Deferred Compensation, the federal Thrift Savings Plan (TSP), Individual Retirement Accounts (IRAs), Health Savings Accounts (HSAs), and various investment options to include rental real estate.

Disclaimer

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