One of the best things (maybe the best thing) about having a Roth IRA is your ability to withdraw money from it without having to pay taxes. However, as is the case with most things concerning the IRS, there are some rules you must follow if you want to reap the benefits of such an amazing perk. And one of the most important is the 5-year rule.

The 5-year rule for Roth IRAs just means you must wait 5 years from a certain point in time (we’ll get into the specifics later) before you can take those tax-/penalty-free distributions. Often, people taking distributions from their Roth IRAs are already complying with the 5-year rule without even knowing it.

However, there are three situations in which it’s important to adhere to the 5-year rule. Otherwise, those withdrawals may be subject to income tax and incur a 10% penalty. Those situations are:

1. Withdrawing earnings from your Roth IRA
2. Withdrawing conversions from your Roth IRA
3. Inheriting a Roth IRA

The Roth IRA Withdrawal Rule: A Quick Refresher

You’re able to withdraw money from your Roth IRA without having to pay taxes because the account was already filled with after-tax contributions—meaning if you’re also taxed on distributions, you would be taxed twice for one sum of money.

Additionally, you can withdraw money from the principal of your IRA (the money from your after-tax contributions) at any time. There’s no magical age you need to reach or threshold you need to cross before you can start taking distributions–as long as you’re only withdrawing from your contributions.

Once you start pulling from other sources, that’s when the 5-year rule comes into play.

Withdrawing Earnings from a Roth IRA

It’s important here to note the word “earnings.” Withdrawing from the principal of your Roth IRA is tax-free, but like any other type of savings or retirement account, Roth IRAs (hopefully) grow over time.

Another point of emphasis is the IRS’s Roth ordering rules. When it comes to your Roth IRA, the IRS stipulates that the money you withdraw should first come from your own contributions, then from conversions, and finally from earnings.

With all that in mind, when withdrawing earnings from your Roth IRA, you must wait at least five tax years after your first contribution into the IRA or that withdrawal may be taxed as regular income and/or incur a penalty of 10% of the withdrawal amount. Additionally, you must be at least 59 ½ to withdraw earnings from your Roth IRA or the same consequences apply.

It should also be noted that the 5-year rule stipulates that you must wait five tax years after your first Roth IRA contribution. If you have multiple Roth IRAs, in the eyes of the IRS, they all count as one. So, if you opened one and started contributing to it five or more years ago, and now you suddenly open a second one and start contributing to it, you don’t need to wait another five years to withdraw from the second account’s earnings.

In the eyes of the IRS, you’ve already passed the 5-year waiting period.

Withdrawing Conversions from a Roth IRA

The 5-year rule also comes into play when you’re withdrawing Roth IRA conversions*. If you’re taking distributions from funds that you previously converted from a Traditional IRA or Traditional 401(k) into your Roth IRA, then you must wait five years again to avoid paying taxes/penalties on those distributions (note that the 5-year waiting rule does not apply to the amount originally converted; only to the earnings portion of the converted amount).

However, unlike withdrawing from earnings, the calendar works a little differently when withdrawing conversions. This time around, the 5-year rule follows more traditional calendar-year rules. This means that if you make a Roth conversion on December 17, 2023, it will be counted as if it was made on January 1, 2023.

If you make a conversion on March 3, 2024, it will be counted as if it was made on January 1, 2024. Any conversions made inside a calendar year will be counted as if they were made on January 1 of that same year. So, to avoid penalties and taxes from your December 17, 2023 conversion, you must wait until January 1, 2028, to take a distribution from those funds.

It’s also important to note that each Roth IRA conversion is subject to the 5-year rule. That means if you made a conversion on December 17, 2022, and a second one on March 3, 2023, you must wait until January 1, 2027, to withdraw funds from the first conversion, and you must wait until January 1, 2028, to withdraw funds from the second conversion.

This is yet another big distinction between withdrawing earned funds and withdrawing converted funds.

However, one similarity between the two is that, once again, you must be at least 59 ½ to take a distribution from converted funds, or you will be subject to income tax and/or a penalty of 10% of the distribution.

Inheriting a Roth IRA

Typically, beneficiaries of an inherited Roth IRA can take distributions–whether the funds are coming from contributions, conversions, or earnings–at any time without fear of taxes or penalties. However, the 5-year rule may still rear its head if the original account owner did not hold the Roth IRA for more than 5 tax years and the funds you’re withdrawing are coming from earnings.

This means that if you inherited a Roth IRA on October 28, 2022, but the first contribution was only made on April 2, 2021, then you must wait until January 1, 2026, before you can take tax-free distributions on any earnings from the account. But this only applies to earnings on the account, and since the IRS Roth ordering rules favor contributions and conversions over earnings, this may end up being a moot point.

Additionally, beneficiaries of Roth IRAs must be aware of the recent rule changes. Previously, beneficiaries needed to start taking required minimum distributions (RMDs) upon the inheritance of qualified accounts like IRAs, Roth IRAs, or 401(k)s. These RMDs could potentially be stretched out over your lifetime. But with the passage of recent legislation, beneficiaries of inherited IRAs must take RMDs based on life expectancy tables, and the account must be fully withdrawn in 10 years.

Spouses are exempt from this rule and can still stretch out RMDs across their lifetime. Because of this drawn-out timeline, it’s possible the 5-year rule could be more of an issue for you now than it would have been in previous years, so make sure you consult a financial advisor on how best to take your RMDs. With a Roth IRA, you may even want to defer withdrawal until the tenth year to benefit from 10 more years of tax-free growth.

What Are the Roth IRA 5-Year Rule Exceptions?

There are certain situations in which the 5-year rule for Roth IRAs can be ignored. You may take tax-free distributions from your Roth IRA at any time, at any age, and from any source (contributions, conversions, or earnings) for any one of the following reasons:

• Making a down payment on your first house (withdrawal amount capped at $10,000)
• Paying for higher education for yourself, your spouse, your children, or your grandchildren (withdrawal amount capped at $10,000)
• Paying for health insurance premiums
• If you become unemployed
• Paying for medical expenses that exceed 10% of your adjusted gross income (AGI)

It’s also worth reiterating that since the IRS’s Roth-ordering rules stipulate that funds for distributions should be taken from contributions to the principal, conversions, and then earnings, in that order, it’s entirely possible that you can avoid the 5-year rule altogether.

If you make enough after-tax contributions to cover your withdrawals, you won’t have anything to worry about.

If you have any additional questions regarding Roth IRAs or the 5-year rule, don’t hesitate to consult your financial advisor.

*Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA. Investing involves risk, including possible loss of principal.

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