What is the Roth IRA five-year rule, and how does it work? This article explains the rule and additional rules you must follow to avoid tax and penalties for taking early withdrawals from a Roth IRA.
The main attraction of having a Roth IRA is the ability to take tax-free distributions in retirement—even on earnings in the account. Contributions are made with dollars you’ve already been taxed on, but earnings in a Roth grow tax free and are not taxed when you take distributions that comply with the rules outlined below.
Perhaps the second main attraction is that you don’t have to be the official retirement age to begin taking tax and penalty-free distributions. You can begin taking distributions when you turn 59 1/2—but only if you’ve had the Roth account for five years. However, there are contingencies on when that clock starts ticking. Read on to learn how it works.
How Does the Roth IRA Five-Year Rule Work?
The Roth five-year rule refers to the specific number of years that you must own your Roth IRA before taking tax and penalty-free withdrawals.
You must own a Roth account for a period of five years before you can take tax-free distributions on the earnings and/or converted funds in the account. If you take distributions of income earned within the Roth IRA during those first five years, the distributions of those gains are taxable. However, the distributions of contributions only are always tax-free.
But when does that Roth five-year rule begin? It doesn’t necessarily start on the day you open and contribute to the account. The minute that clock starts ticking depends on they year you report your first contribution to the account on your tax return.
IRS Rules for the Five-Year Rule
Yes, there are rules the IRS has for the five-year rule you must follow to avoid not only taxation of earnings in your Roth IRA, but penalties, too.
When does the five-year clock start?
The IRS mandates that the start of the five-year clock depends on when you open your account and in which tax year you report your first contributions to it.
This is critical and contingent on the day you open your account—because you 
may gain a few extra months or even an entire year of ownership.
Here’s how…
The IRS allows Roth owners to open and make yearly contributions to new accounts until April 15th of the following tax year and include contributions to the account on the previous year’s tax returns.
For example, you can open and make contributions to your Roth IRA before April 15, 2024, and declare those contributions on your 2023 income tax report. Let’s say you open and fund your account on April 14, 2024, and attribute the contribution to the account on your 2022 income tax return. The date of your Roth IRA ownership is “rolled back” to January 1, 2022 (which gives you an extra year and 3 and a half months of ownership towards the five-year rule).
If you open your account in August or even December of 2023 your ownership date is rolled back to January 1, 2023. In this case, you can have technically owned the Roth IRA for a period of approximately four years, but have it classified as five—depending on when you open it and in which tax year your first contribution goes toward.
When can you take distributions from a Roth IRA?
A Roth IRA allows two different types of distributions: you can take a distribution of your contributions and you can also take a distribution of the earnings the account accrues. Distributions of funds in the account always start with your initial contributed funds.
1. Distributions of contributions
You can take tax and penalty-free withdrawals of your contributions to a Roth IRA regardless of how long you have owned the account or your age. This is a great benefit and another reason why Roth IRAs are favored retirement plans.
2. Distributions of earnings
You are unable to take tax-free and penalty-free distributions of earnings until you reach the age of 59 1/2 and have owned the account for the five-year time frame explained earlier in this article.
If you are 59 1/2 and older but haven’t owned your Roth for five years, you’ll pay taxes on withdrawals of earnings. You won’t owe the 10 percent early-withdrawal penalty since you meet the age requirement. But if you are under 59 1/2, you will pay that penalty as well as the tax.
If you’re younger than 59 1/2 and have had your Roth account for five plus years, there are reasons you may avoid taxes and penalty on early withdrawals of earnings. A few examples include if you’re disabled or if you take a maximum of a $10,000 withdrawal to buy your first home. We urge you to seek appropriate professional advice before taking a withdrawal to ensure you meet IRS requirements to potentially avoid tax and penalty.
It’s important to understand that the above applies to new Roth accounts. The process is a bit different for Roth IRA conversions.
How does the five-year rule work for Roth IRA conversions?
If you are performed a Roth conversion of funds from a pre-existing individual or employer-sponsored retirement plan into a Roth IRA, you must perform the conversion by December 31 of the tax year you want the converted funds to count towards.
For example, if you want your converted funds to be reported on your 2023 tax return, you must perform the conversion on or before December 31, 2023. Conversions made after that date are not allowed to be attributed to the previous tax year. But, if you perform a conversion in August of 2023, your starting clock rolls back to begin on January 1, 2023.
Please note the five-year rule applies to every Roth conversion you perform, so you may end up with multiple five-year rules you must follow for each conversion.
This is critical because you don’t want to withdraw an amount that exceeds the total of your earliest converted funds that satisfy the five-year rule if you want to avoid tax and penalties.
The typical order of distributions from retirement plans is as follows:
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- Contributions come out first.
- Converted amounts are withdrawn next.
- Distributions of earnings are last.
Specific rules for distributions of converted funds:
If you’re 59 1/2 and older:
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- You can take immediate tax and penalty-free withdrawals of converted funds only, even if you don’t meet the five-year rule.
- But any earnings attributed to those converted funds must meet the five-year rule, otherwise you’ll pay tax and penalty on withdrawals of those earnings.
If you’re under 59 1/2:
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- You’ll pay tax and penalty if you withdraw converted funds—even if you meet the five-year rule.
- You’ll also pay tax and penalty if you withdraw earnings on those converted funds and don’t meet the five-year rule.
- And you’ll pay an early-withdrawal penalty if you withdraw earnings attributed to converted funds even if you meet the five-year rule, but you’ll avoid tax on those earnings.
Distributions of Roth conversions can be somewhat tricky due to the five-year rule, so we encourage you to seek professional advice to avoid unnecessary taxation and/or penalties.
Final Words on the Roth IRA Five-Year Rule from Advanta IRA
Advanta IRA is a self-directed retirement plan administrator serving clients across the nation, with over 2.5 billion in assets under management. We administer record-keeping for clients who use self-directed IRAs and solo 401(k)s to invest in alternative assets and guide them throughout each investment process.
We do not sell investments or give advice on investments. We also do not provide tax and legal advice. This article was written to give you the basic details regarding the Roth IRA five-year rule, so you have a better understanding on how it works for Roth IRAs and Roth converted funds. We always advise our clients, investors, and individuals to work with their CPAs and other informed professionals for guidance to ensure IRS compliance of the five-year rule.
We’d also like you to know that…
You Can Use a Self-Directed Roth IRA to Invest in Alternative Assets
The fact that Roth IRAs can be self-directed makes these retirement plans even more attractive to savvy investors. Self-direction provides plan owners the ability to control their own retirement funds and investing decisions. Additionally, investors gain access to many different types of alternative investments such as real estate, precious metals, cryptocurrency, private lending opportunities—and much more—to build wealth for retirement.
Visit the self-directed Roth IRA section on our web site to learn more about how these plans work as well as the how tax-free withdrawals are distributed.
If you have questions about this article or want to learn more about self-directed retirement plans, please contact Advanta IRA.
Additional articles on self-directed IRAs and alternative assets:
Roth IRAs vs. Traditional IRAs: A Comparison of the Benefits and the Differences
How Do Roth IRA Conversions or Backdoor Roth IRAs Benefit You in Retirement?
Solo 401(k)s vs SEP IRAs vs SIMPLE IRAs: Retirement Plans for Small Business Owners
10 FAQs about a Self-Directed IRA (SDIRA) + Alternative Investments
