Download the free Roth IRA distribution flowchart.
Download the free 5-year rules PDF guide.
Additional resource: To see the tax and/or penalty consequences of 11 different Roth IRA distribution scenarios, click here.
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 a tax wrapper for your investments. You can have an S&P 500 index fund in a traditional IRA and a Roth IRA. You can have an S&P 500 index fund in a traditional employer sponsored retirement plan like the Thrift Savings Plan (TSP), a 401(k), 403(b), or 457. You can also have an S&P 500 index fund in a Roth employer sponsored retirement plan. The investment stays the same – the difference is the tax treatment.
Traditional (pre-tax) = Don’t pay tax on the money you contribute now, it grows tax-deferred, and eventually can be withdrawn later at which point it will be taxed as ordinary income. This money grew without ever being taxed, so at some point you, or your heirs, will have to pay tax on it.
Roth (post-tax) = Pay tax on the money you contribute now, it grows tax-free, and eventually you can withdraw all of the money tax-free…if you play by the rules. What rules? That's what we'll be covering with these two five-year rules.
Trust, but verify.
Very few topics in the finance world are as misunderstood as the two separate 5-year rules. I’ve seen a handful of articles from very reputable sources that contain inaccurate information regarding these rules. This should serve as a reminder that despite the company being a “big-name” company, at the end of the day, these institutions are run by humans, who can make mistakes. The same goes for the Thrift Savings Plan. There is absolutely nothing wrong with questioning something that seems off. When it comes to the financial media and 1-800 customer service centers, trust, but verify.
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 a direct Roth IRA contribution
There ARE NOT income limits to contribute towards your Roth TSP.
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).
Too Long Don't Read
If you can only remember 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.
5-Year Rule #2 / “5-Year Conversion” Rule
Only determines if a 10% additional tax/penalty will apply to converted principal, when distributed from a Roth IRA.
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 really make sense.
Withdrawal of Roth IRA Contributions
Roth IRA contributions can be withdrawn at any age, for any reason, without tax or penalty. Full stop.
“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
Ordering Rules
As mentioned on page 33 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 (on a first-in-first-out basis)
(a) Taxable portion first, then
(b) Non-taxable portion
(3) From earnings.
You don’t move on to withdrawing earnings until you’ve depleted the conversion bucket. You don’t move on to 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 and Roth balance, the distribution will contain a portion of contributions and earnings. You cannot withdraw just your Roth TSP contributions.
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 were the Roth earnings taxed? Isn’t the whole point that the Roth is tax-free? In this example from TSP BK26 – the individual is 57-years-old. They took a distribution before turning age 59 ½, which means those Roth earnings are non-qualified and therefore taxable.
So, how do these earnings become “qualified”? This is why you need to understand 5-Year Rule #1.
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 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 § 408A(d)(4) & 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 of how distributions commonly work.
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 ($26,000 total 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.
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 Distribution (QD). Qualified distributions are tax and penalty free. QD has a two-prong test that must be satisfied.
(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 a $1 contribution to a Roth IRA on April 15, 2025, and it’s a contribution for tax year 2024, your 5-year clock starts January 1, 2024 even though you contributed April 15, 2025.
Source: A-2 of 26 CFR § 1.408A-6.
(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 that 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: Page 31, What Are Qualified Distributions, IRS Publication 590-B
“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.
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 #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 employees to withdraw money from their TSP penalty-free when they separate from service at age 55 or older does not apply to the Roth TSP. Special Category Employees can withdraw traditional TSP funds without the 10% penalty at age 50, or any age when they have completed 25-years of service, but not from their Roth TSP.
The earnings portion of your Roth TSP becomes available tax and penalty free (“qualified”) once you’ve satisfied the 5-Year Rule #1 and you’re either 59 ½, disabled, or dead.
Here's the proof straight from TSP.
What 5-Year Period Do You Use if You Transfer / 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.
What if you had a Roth TSP for 5-years, does that transfer to the Roth IRA and satisfy 5-Year Rule #1? No.
If you retire at age 60, open your very first Roth IRA (you’ve never had a Roth IRA ever before), transfer your Roth TSP into your Roth IRA, and make withdrawals, you will be taxed on earnings because the distribution was not "qualified".
Why? You didn’t satisfy QD prong #1, the “5-Year Forever” rule.
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.”
“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 rollover one of these designated Roth accounts into the other, 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: 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.
A) Non-Qualified Distribution from Roth TSP 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.
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.
B) Qualified Distribution from Roth TSP 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.
However, there could be a catch if you have not satisfied 5-Year Rule #1/ 5-Year Forever Rule, with any Roth IRA.
Let’s say you have $80,000 contributions and $20,000 earnings in your Roth TSP. You are over 59 ½ and have had your Roth TSP for at least 5 tax years. You can take the entire $100,000, roll it into your Roth IRA, and it’ll be treated as basis. This $100,000 can come out 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.
“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
*Note: TSP withdrawal rules apply – 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 hardship withdrawals and age 59 1/2 in-service withdrawals.
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 convert traditional (pre-tax) money to a Roth IRA, and you’re under age 59 ½, you cannot withdraw those converted dollars without paying a 10% additional tax/penalty on the taxable converted amount until 5 tax years have passed (unless another exception applies). The 5-year clock starts January 1st of the year you do the conversion. Each conversion has its own 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 5-Year Rule #2/ 5-Year Conversion Rule, you’ll owe a 10% penalty on this $10,000. You will not owe any income tax because you already paid tax on that $10,000 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 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 (5-Year Rule #1/5-Year Forever Rule (+) age 59 ½, or disabled, or dead).
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. Don’t forget the ordering rules.
“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: page 33 of 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.”
Source: page 33 of 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.”
From page 33 of IRS Publication 590-B
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 (hopefully) made up of Roth contributions.
Generally, this 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, since 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 bond or CD ladders, 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.
If You Make a “Backdoor” Roth IRA Contribution, Does the 5-Year Conversion Rule Apply to the Non-Taxable Converted Amount?
No. The 5-year conversion rule does not apply to non-taxable converted amounts.
Why? If you make a non-deductible contribution of $7,000 from your bank account to a traditional IRA, and then convert that post-tax $7,000 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.
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: page 33 of 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.
(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
Pretty simple, BUT, don’t forget the ordering rules when thinking through this.
Sometimes, when executing a “backdoor” Roth IRA contribution, some earnings growth will accumulate before the conversion is executed. For example, a $7,000 non-deductible contribution made to a traditional IRA may grow to $7,005 before converting. That $5 growth can be converted along with the $7,000, resulting in $7,005 landing in your Roth IRA. That $5 worth of earnings will be taxable income that year. Not a big deal.
However, if you then tried to withdraw $7,000 from your Roth IRA, and had never made contributions before doing this $7,005 “backdoor” contribution, you would not be pulling the $7,000 non-taxable converted amount first. The ordering rules tell us that taxable amounts (in this example, the $5 included in gross income the year of conversion) are distributed first. This $5 taxable converted amount would be subject to its own 5-Year Conversion Rule.
So, if you distributed $7,000 (and had no prior contributions or prior taxable conversions) you’d actually be taking $5 taxable converted amount (which would be subject to the 10% penalty if distributed within 5 tax years, but not income tax) and $6,995 non-taxable converted amount (which is not subject to tax or a 10% penalty).
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 IRA prior to age 59 ½ at all costs. 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.
If you’re 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. What about 5-year rule #2? It doesn’t apply to you because you’re over age 59 ½.
If you’re under age 59 ½ –
I’ll stress this again, you should really avoid touching any part of your Roth IRA, especially when you have decades to let it compound tax-free. If you absolutely need to withdraw from your Roth IRA, remember contributions can be withdrawn at any time with no tax or penalty. Keep track of your contributions and make sure you’re filing IRS Form 8606 for all “backdoor” contributions.
Download the two 5-year rule guide here:
About the Author
Tyler Weerden, CFE is a financial planner and the owner of Layered Financial, a Registered Investment Advisory firm. In addition to being a financial planner, Tyler is a full-time federal agent with 15 years of law enforcement experience on the local, state, and federal level. 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 Arrangements (IRAs), Health Savings Accounts (HSAs), and invests in rental real estate. He holds a Bachelor of Science degree, a Master of Science degree, passed the Series 65 exam, and is a Certified Fraud Examiner (CFE).
Disclaimer
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