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Follow the rules to avoid a penalty

Quick Summary

  • You can withdraw your Roth IRA contributions tax-free at any time.
  • To withdraw earnings tax-free, you have to be age 59 1/2 or older and the account must be at least five years old.
  • If you don’t follow these rules, you might owe taxes and a 10% penalty.

As most investors are well aware, there are several rules that you must abide by when you contribute to a Roth IRA. There are also rules for Roth IRA withdrawals. One rule that investors may not realize is that you must have owned your Roth IRA for five years in order to withdraw earnings tax-free during retirement. That’s the Roth IRA 5-year rule. Here’s what you need to know.

What Is the 5-Year Rule?

You can withdraw your contributions to a Roth IRA at any time, for any reason, without tax or penalty. But that doesn’t apply to any earnings or interest that you’ve earned on your Roth IRA investments.

To withdraw your Roth IRA earnings tax-free and penalty-free, you must you be over age 59 ½ and your initial contribution must have been made at least five years before the date when you start withdrawing funds. If your account doesn’t meet this 5-year rule, withdrawals on earnings won’t be considered a qualified distribution.

How Are the Five Years Calculated?

The 5-year rule clock starts ticking on Jan. 1 of the year you make your first contribution to a Roth IRA. Because you can make a Roth IRA contribution up to April 15 of the next year, your five years might not be a full five calendar years.

If you made a Roth IRA contribution in February 2020 and designated it for the 2019 tax year, for example, you’d have to wait only until Jan. 1, 2024 to withdraw your Roth IRA earnings tax-free. Of course, this assumes that you’re over 59 ½ at that time so it’s a fully qualified withdrawal.

The clock starts with the very first contribution you ever deposited into any Roth. This isn’t the case with a Roth IRA conversion. The 5-year rule clock restarts for every conversion you make with the amount and date the funds were converted.

What Happens If You Violate the 5-Year Rule?

There are exceptions that allow you to withdraw earnings from your Roth IRA tax-free before you reach the age of 59 ½. For example, you can use the money for a first-time home purchase, if you have a disability, or if you pass away (and your beneficiary takes the distribution). But none of those exemptions save you from having to abide by the 5-year rule for Roth IRA withdrawals.

Your withdrawals may be subject to taxes and a 10% penalty, depending on your age and if you meet the 5-year rule. Here’s a rundown.

If you meet the 5-year rule:
  • Under 59 ½: Withdrawals on earnings are subject to taxes and penalties. You may be able to avoid taxes and penalties if you use the money for a first-time home purchase, if you have a disability, or if you pass away (and your beneficiary takes the distribution).
  • Over 59 ½: No taxes or penalties.
If you don’t meet the 5-year rule:
  • Under 59 ½: Withdrawals on earnings are subject to taxes and penalties. You may be able to avoid the penalty (but not the taxes) if you use the money for a first-time home purchase, qualified education expenses, unreimbursed medical expenses, or if you have a disability or pass away (and your beneficiary takes the distribution).
  • Over 59 ½: Earnings are subject to taxes but not penalties.

Of course, taking an early withdrawal—and racking up taxes and penalties—can quickly erode your Roth IRA. Because of the potentially steep financial consequences, you should always think twice before taking money out before you’re age 59 1/2 and before you meet the 5-year rule. Consult with a qualified financial planner or advisor if you have questions about your situation.

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