James explores the nuanced aspects of Roth IRAs, shedding light on intricacies that can confound even experienced investors.
Through a listener question from Manfred, a retiree contemplating a $50,000 conversion from a 401k to a Roth account, James dissects the crucial five-year holding period and the order in which contributions, conversions, and earnings are treated during withdrawals.
James also provides clarity on distribution rules, exceptions, and strategic considerations, offering a comprehensive guide to navigating the complexities of Roth IRAs for optimal retirement planning.
Questions Answered:
How does the timing of subsequent conversions impact the application of the five-year rule?
In Roth IRA withdrawals, what is the specific order of operations, and what implications does that have?
PDF Cheatsheet:
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⏱Timestamps:⏱
0:00 Manfred’s question
1:39 Get the cheatsheet
2:37 Understanding source nuances
7:01 The five-year rule
8:37 IRS’s order of operations
11:59 Exceptions to the rule
13:49 Only a small impediment
16:14 Back to Manfred’s example
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Roth IRA Tax-Free Withdrawals: 5-Year Rule Explained
When it comes to retirement savings, a Roth IRA is a popular choice for many individuals. One of the key benefits of a Roth IRA is the ability to make tax-free withdrawals in retirement. However, there are specific rules and regulations that govern these tax-free withdrawals, including the 5-year rule.
The 5-year rule refers to the requirement for a Roth IRA account to have been open for at least five years before any earnings can be withdrawn tax-free. This means that if you open a Roth IRA and make contributions, you will need to wait at least five years before you can withdraw any investment earnings without paying taxes on them.
It’s important to note that the 5-year rule is calculated based on the tax year in which the first contribution was made, not the calendar year. For example, if you make your first Roth IRA contribution on April 1, 2022, the 5-year clock starts on January 1, 2022.
There are also some exceptions to the 5-year rule. For example, if you are over the age of 59 ½ and have had a Roth IRA open for at least five years, you can make tax-free withdrawals of both contributions and earnings. Additionally, if you become disabled or use the funds for a first-time home purchase, you may also be able to make tax-free withdrawals without meeting the 5-year requirement.
Understanding the 5-year rule is important for anyone who has a Roth IRA or is considering opening one. It’s important to plan ahead and be aware of the potential tax implications of withdrawing funds from a Roth IRA before meeting the 5-year requirement.
For many individuals, the tax-free withdrawals offered by a Roth IRA can be a valuable source of retirement income. By understanding the rules and regulations governing these withdrawals, you can maximize the benefits of your Roth IRA and make informed decisions about your retirement savings.
In conclusion, the 5-year rule is an important aspect of Roth IRA tax-free withdrawals. By understanding this rule and any exceptions that may apply, you can make the most of your Roth IRA and enjoy tax-free income in retirement. It’s always a good idea to consult with a financial advisor or tax professional to ensure that you are making the best decisions for your retirement savings.
So glad I found your channel. Thank you!
can you do video on which to take ACA subsidies vs Roth Conversions before 65 y.o. can you take both subsidies and do Roth conversion the same year
can you do advantage of ACA subsidies vs Roth Conversion before 62.y.o. can you do both the same year if at low ( less than 50 K )or no income)
This was very helpful. I am Not 59.5 yet, but have a Roth IRA since 2012. The message I am getting is that everybody could benefit by investing $ into Roth IRA, esp. since you could take out ur contribution if absolutely needed it. Obviously want to have emergency fund set up first, but really good video for back pocket info. Thank you!!
Question: if you complete Roth Conversions of your Traditional IRA or 401k, and god forbid pass away before the 5 year holding period for the conversion, does this trigger any issues for a Spouse or child inheriting the Roth IRA?
Thanks for the cheat sheet. Could you make the light colored boxes a different color? There is not enough contrast when printing the sheet – it is difficult to read the words.
There is no distribution penalty as long as you are over age of 59.5 according to the IRS document section below.
Department of the Treasury
Internal Revenue Service
Publication 590-B
Cat. No. 66303U
Distributions
from Individual
Retirement
Arrangements
(IRAs)
For use in preparing
2022 Returns
"Distributions of conversion and certain rollover con-
tributions within 5-year period.
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 or roll over an
amount from a qualified retirement plan to a Roth 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 attrib-
utable to the part of the amount converted or rolled over
(the conversion or rollover contribution) that you had to in-
clude in income (recapture amount). A separate 5-year
period applies to each conversion and rollover. See Or-
dering Rules for Distributions, later, to determine the re-
capture amount, if any.
The 5-year period used for determining whether the
10% early distribution tax applies to a distribution from a
conversion or rollover contribution is separately deter-
mined for each conversion and rollover, and isn't neces-
sarily the same as the 5-year period used for determining
whether a distribution is a qualified distribution. See What
Are Qualified Distributions, earlier.
For example, if a calendar-year taxpayer makes a con-
version contribution on February 25, 2022, and makes a
regular contribution for 2021 on the same date, the 5-year
period for the conversion begins January 1, 2022, while
the 5-year period for the regular contribution begins on
January 1, 2021.
Unless one of the exceptions listed later applies, you
must pay the additional tax on the portion of the distribu-
tion attributable to the part of the conversion or rollover
contribution that you had to include in income because of
the conversion or rollover.
You must pay the 10% additional tax in the year of the
distribution, even if you had included the conversion or
rollover contribution in an earlier year. You must also pay
the additional tax on any portion of the distribution attribut-
able to earnings on contributions.
Other early distributions. Unless one of the exceptions
listed below applies, you must pay the 10% additional tax
on the taxable part of any distributions that aren't qualified
distributions.
Exceptions. You may not have to pay the 10% additional
tax in the following situations.
• You have reached age 59 1/2.
• You are totally and permanently disabled.
• You are the beneficiary of a deceased IRA owner.
• You use the distribution to buy, build, or rebuild a first
home"
Great video James!
When you move after-tax non-Roth funds from a 401k to a Roth IRA, is that mega backdoor which is really a rollover also considered a conversion?
Same question if you move a Roth 401k to a Roth IRA ?
Thanks.
James,
This is one of the best Roth conversion, waiting period, and tax implications videos that I have ever seen or come across in youtube. I've been following you for more than 6 months and I enjoy every video about retirement, conversion, budgets, and tax implications during the retirement.
I have been saving your videos into a playlist so that I can really listen whenever I want like a library.❤
MUST WATCH VIDEO
You may want to add to your cheat sheet 401K conversions along with traditional IRSs.
James…thanks a million for the Roth IRA decision metric flow chart–it definitely explained the complicated Roth IRA or Roth Conversion IRS rules in layperson terms. Most important–thanks–for the explanation at the end of the video where you advised that anyone contemplating during Roth Conversion (where the goal should be to leave the money in the Roth account) to grow tax-free [for decades]) to take advantage of the Rule of 72–compounding interest–where one is allowed the conversion(s) to double, triple, and so forth in value. And most important allowing one to avoid RMDs.
If retiring early Roth funds can be used to keep your agi low to qualify for low cost heath insurance from the ACÁ.
Good video, but for some reason I think the second 5 year rule is you must have a Roth for at least 55 years, not the Roth.
I had a 401K at a company I was working at, but transitioned to a new job. I reached out to my banker for recommendations for having it rolled over into an existing IRA Roth account at my bank, but I noticed they had opened a separate Brokerage IRA account with this money from the 401K. So, I am wondering why I have two separate IRA brokerage accounts. Is there an option to consolidate it into my my main IRA Roth brokerage account without any tax penalty? I just don't get the point of having two and I have not even seen any growth in that one account, but I contribute 6k to the main one every year.
James, I am 64 and established a ROTH back between 2006 to 2011. During that time period, I made deposits and yearly Traditional IRA conversions into the ROTH. Those are long since settled. I set up a ROTH conversion this week and I had taxes withheld. This conversion is a “tanked” stock position that had lost considerable value. I have a second similar conversion that will probably be made at the first of the year again with taxes paid at conversion. Both stocks can recover in the ROTH and hopefully increase the value. I appreciate this video as it answers quite a few questions.
I’m boxed in due to an ACA policy. Convert while you have employer health care!
That is a great question. Thank you for taking it on sir.
Can you please help explain roth 401k/ roth403b any taxes on any of these? Should we convert more before 2026 new tax? Thank you for your teaching . All are awesome.
James please read IRS publication 590-B, you are incorrect in saying that a 5 year conversion clock applies in the scenario in this video.
Thanks for a great video. Your explanation was very comprehensive and crystal clear. I do have one question. I am soon to be 70, and like Manfred, I took 6K from my traditional IRA and converted it into my Roth. So, if I have to wait for the 5-year rule to benefit my gains from the conversion, by the time I can reap the benefits, I may have died. Or forget the conversion and take the taxable RMD from my traditional IRA at 73y/o?
Thank you James. In-depth, but easy to follow videos are so helpful. I really appreciate your communication style and breadth of knowledge.
Does the five year clock start when the account is opened or funded?
I opened an account a few months ago as i am expecting an inheritance but still have not received it yet.
Thanks
Houma Louisiana
Benefits for retiree Roth Conversion is so heirs get it tax free, no RMDs or 10 yr limit.
This is interesting topic to me. I was planning to use a large Roth distribution to purchase a home at some point after I retire. However, in the early retirement years, I want to do a series of Roth conversions, ending a year or 2 before the big distribution. I'm pretty sure I'd be clear of any penalties, based on my projections, although, I don't know the actual numbers at this point because this isn't going to happen for quite a few years. This money will be coming out of a tax deferred IRA, so there are major tax implications of leaving it in there and then taking a huge distribution when I'm ready to buy the house. I could just take smaller annual distributions and set that money aside in cash instead of converting it, but I don't want to miss out on years of growth. I know, I'm trying to have my cake and eat it too, but I hate the idea of leaving 100s of thousands of dollars sitting in cash for years.
Maybe I misunderstood what you said, but I see others are questioning as well. I think if you are over 59.5 and have had the Roth open for at least 5 years, conversions are available for immediate withdrawal as soon as they are converted with no penalty. I think you said all conversions had their own 5-year rule, even after 59.5. Did I misunderstand what you said or is my description inaccurate?
Very interesting and informative. I am slightly over age 59.5 and will soon do annual conversions in large sums perhaps into early 70's. I have existing long time Roth acct already. For my conversions do you recommend I create separate accounts each year due to the 5 year time lock as an easier way to keep track of this vesting? Is this common practice?