By Sarah Brenner, JD
Roth IRAs first arrived over twenty years ago. A lot has changed since 1998. That was the year that Google was founded and an electronic pet called a Furby was one of the most popular Christmas gifts. However, some things haven’t changed so much. Impeachment is once again all over the news and here at the Slott Report we are still being asked many questions about how the five-year rules for Roth IRA distributions work. We probably get more questions on this topic than just about any other.
How the Rules Work
A good deal of the confusion about the Roth IRA distribution five-year rules stems from that fact that there are two separate rules that each work differently.
There is one for penalty-free distributions. It applies only if you are under 59½ years old and only to conversions. This five-year holding period will restart with every conversion you do.
The other five-year rule is used to determine if a Roth distribution of earnings is a qualified distribution and income tax-free. This five-year holding period starts when your first Roth IRA account is established. It does not restart for each Roth IRA contribution or conversion.
Why You Should NOT Care
Are you a little confused? Don’t worry about it. Think of the big picture. It is, of course, always helpful to be educated about the retirement account rules and understand what you are getting into when you take a distribution. However, if you are using your Roth IRA as intended with the goal of putting money away for future retirement, none of these complicated rules should affect you at all. If you keep your Roth IRA intact over the long term and until you reach retirement age, the rules could not be easier. All your distributions are completely tax and penalty-free! Nothing to it!
If you are thinking of converting, but are very concerned about failing to meet the Roth IRA five-year holding periods, this may be a warning sign that maybe a Roth IRA conversion is not for you. To get the most bang for your buck with a Roth IRA, you need time. You should be in it for the long haul. Not only are the rules less complicated this way, but it is the only way you can really maximize the big tax benefit of the Roth IRA: long term accrual of tax-free earnings.