What it means
A Roth IRA is a US retirement account funded with after-tax money, and its growth can be withdrawn tax-free if the rules are met. Contributions can always be taken out without tax because they were taxed earlier.
The earnings are different, and the five-year rule is one of the tests for a qualified, tax-free withdrawal. The clock starts on 1 January of the tax year for which the first contribution to any Roth IRA is made.
This means a contribution made in April for the previous tax year can start the clock earlier than you might expect. After five tax years have passed, the period is satisfied for all of that person's Roth IRAs.
The second requirement is a qualifying event, most commonly reaching age 59 and a half, but also death, disability or certain first-time home purchase withdrawals. If you meet only one of the two tests, the earnings part of your withdrawal may be taxed and could face an extra 10% early withdrawal charge.
Exceptions exist, so personal advice matters. Roth conversions, where money is moved from a traditional IRA to a Roth, have their own five-year period for avoiding the early withdrawal charge on the converted amount.
Each conversion has a separate clock. Beneficiaries who inherit a Roth account can also face time rules, so the label five-year rule covers several related tests.
For planning, the main lesson is to open and fund a Roth early, even with a small amount, so the clock starts. It is also wise to keep clear records of each contribution and conversion year.
Tax rules change, so always check current guidance from the tax authority or a qualified adviser.
In practice
Real-world examples.
Example
A 45-year-old opens a Roth IRA with a $2,000 contribution. Her five-year clock starts for that tax year, so by the time she is 59 and a half the five-year test is long satisfied.
Example
A 58-year-old opens his first Roth IRA and converts $100,000 from his traditional IRA. At 59 and a half he meets the age test, but if he withdraws earnings before five tax years have passed the earnings may not be tax-free.
Example
A retiree wants to withdraw the earnings from an account she opened three years ago. Her adviser explains that she must wait two more tax years for the five-year test and, until then, she should take contributions only.
Formula
Calculation
Withdrawals from a Roth IRA that are not qualified are generally treated as coming out in a set order: contributions first, then conversions, then earnings.
Taxable amount of a non-qualified withdrawal = Withdrawal - Contributions and conversions not yet taken out, with any remainder treated as earnings
Worked example: a Roth IRA is worth $52,000, made up of $40,000 of contributions and $12,000 of earnings. The owner is under 59 and a half and the five-year period has not been met, and withdraws $45,000.
First $40,000 comes from contributions: tax-free
Remaining $45,000 - $40,000 = $5,000 comes from earnings: taxable
The owner reports $5,000 as taxable income, and an additional 10% early withdrawal charge of $500 may apply unless an exception covers it.Case study
Seen in the real world.
Aaron is a fictional engineer who opened his first Roth IRA at age 52 with a small contribution of $500, mainly to start the clock. Six years later he rolled a larger amount into it and planned to retire at 60.
In this illustrative case, Aaron's adviser showed that the five tax years counted from the first contribution, not from the larger rollover, so the test was met before retirement. He could then take tax-free withdrawals including earnings once he reached 59 and a half. The story shows how a small early step can help a later, bigger plan, although conversion rules can add separate clocks.
Watch out
Common mistakes.
- Starting the clock from the date of the large conversion. For earnings, the clock normally runs from the first Roth IRA contribution year, though conversions have their own separate period for penalty purposes.
- Thinking age 59 and a half alone is enough. Both the age test and the five-year test usually have to be met for earnings to be tax-free.
- Not keeping records. Without records of contribution years and amounts, proving the right treatment later can be difficult.
Questions
People also ask.
Does the five years mean 60 months?
Not exactly. It is counted in tax years starting on 1 January of the first contribution year, so the actual time can be a little shorter than five full years.
Does the rule apply to traditional IRAs?
Not in the same way, since traditional IRA withdrawals are generally taxable. It is mainly a Roth test, with some related five-year rules for conversions and certain plans.
Does opening a second Roth IRA restart the clock?
Usually not. The clock starts with your first Roth IRA contribution and covers your other Roth IRAs, though employer plans have separate rules.
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