What is the 5-Year Rule?
The phrase “5‑year rule” appears in several contexts involving IRAs. Most commonly it refers to the waiting period required before Roth IRA earnings can be withdrawn tax‑ and penalty‑free. It also applies to certain Roth conversions and to some distribution rules for inherited IRAs (especially for accounts opened or decedents who died before the SECURE Act changes). Because the rule has different meanings depending on whether the account is a Roth, a conversion, or an inherited IRA, it’s important to know which version applies to your situation.
Key takeaways
– For Roth IRAs, contributions can be withdrawn at any time tax‑ and penalty‑free; earnings require a 5‑taxable‑year holding period plus a qualifying reason (generally age 59½) to be tax‑free. [IRS Pub. 590‑B]
– Each Roth conversion has its own 5‑year period to avoid the 10% early‑withdrawal penalty on converted amounts (even if the funds would otherwise be tax‑free). [IRS Pub. 590‑B]
– Inherited IRA rules changed under the SECURE Act (effective for deaths after 2019): many non‑spouse beneficiaries must withdraw the account within 10 years. Older “5‑year rule” options may still apply in certain pre‑2020 death cases. [IRS Retirement Topics – Beneficiary]
– Always confirm the relevant dates: date of first Roth contribution, date of conversion(s), and date of decedent’s death determine which rule and timetable apply. [Investopedia; IRS Pub. 590‑B]
How the 5‑Year Rule Works: Roth IRAs (earnings)
– What it means: To have a “qualified distribution” from a Roth IRA (so earnings are tax‑free), two tests must be met:
1) The Roth IRA must have existed for at least five tax years (the 5‑year rule), and
2) The distribution must be made because you are age 59½ or older, disabled, using up to $10,000 for a first‑time home purchase, or on account of your death.
– When the 5‑year clock starts: It begins on January 1 of the tax year for which you made your first contribution to any Roth IRA (including conversions that are treated as contributions for this purpose). If your first contribution was for tax year 2018 (even if made in April 2019), the 5‑year period is counted from Jan 1, 2018. [IRS Pub. 590‑B]
– Order of Roth withdrawals: The IRS ordering rules treat distributions as coming first from contributions (always tax/penalty free), then from conversions (subject to conversion‑specific 5‑year rules for penalty avoidance), and lastly from earnings. [IRS Pub. 590‑B; Investopedia]
Roth conversion 5‑Year Rule (penalty protection on converted amounts)
– Each conversion (traditional IRA → Roth IRA) has a separate 5‑year period for determining whether distributions of converted amounts are subject to the 10% early‑withdrawal penalty.
– The five‑taxable‑year period for a conversion begins on January 1 of the year in which you converted. If you withdraw converted amounts within that 5‑year window and you are under age 59½ (and no exception applies), you can owe the 10% penalty on the non‑taxable (converted) portion even though taxes were already paid on the conversion. [IRS Pub. 590‑B]
Inherited IRAs and the 5‑Year Rule
– Changes under the SECURE Act: For account owners who died in 2020 or later, many non‑spousal beneficiaries must empty the inherited IRA within 10 years (no annual RMDs required during the 10‑year period for many beneficiaries). Eligible designated beneficiaries (EDBs) — e.g., surviving spouses, minor children (until they reach majority), disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the decedent — may still stretch distributions over their life expectancy. [IRS – Retirement Topics – Beneficiary]
– Pre‑2020 “5‑year rule” (older rules you may encounter): When the owner died before 2020 and other conditions applied, beneficiaries could sometimes elect a 5‑year payout method (take all distributions by December 31 of the fifth year after death) instead of annual RMDs. That 5‑year rule also carried the 5‑year requirement for Roth earnings to be tax‑free: if the original owner hadn’t held the Roth for five tax years at death, a beneficiary who takes earnings may owe tax on the earnings until the five‑year period is met. [IRS Pub. 590‑B; Investopedia]
– Inherited Roth IRAs: If the original owner’s Roth had met the 5‑year holding period at the date of death, distributions to beneficiaries are tax‑free (provided the distribution rules for the type of beneficiary are met). If the Roth had not met the 5‑year rule at death, earnings distributed to beneficiaries are taxable until the 5‑year period has elapsed. [IRS Pub. 590‑B]
Does the Roth 5‑Year Rule Apply if You’re 59½ or Older?
Yes. Meeting age 59½ alone does not automatically make Roth earnings tax‑free — the 5‑year holding requirement must also be met. To have tax‑free treatment of earnings you generally must satisfy both the age (or other qualifying reason) and the 5‑year rule. [IRS Pub. 590‑B]
What is the 2‑Out‑Of‑5‑Year Rule?
Not related to IRAs: for the home‑sale capital gains exclusion, you must have owned and used the home as your primary residence for at least two of the five years preceding the sale to exclude up to $250,000 ($500,000 for married filing jointly) of gain from income.
Practical steps — If you own a Roth IRA
1. Determine the Roth clock start date:
– Find the tax year of your first Roth contribution or conversion.
– Record Jan 1 of that year as the start of the 5‑year clock for qualified distributions.
2. Track conversions separately:
– Keep records for each conversion and its conversion year; each conversion’s five‑year period matters for penalty avoidance.
3. Plan withdrawals in order:
– Withdraw contributions first (no tax or penalty), then converted amounts (watch conversion‑specific 5‑year rules), then earnings.
4. If you need to withdraw before meeting both tests:
– Consider exceptions (first‑time homebuyer up to $10,000, disability, death).
– Expect earnings withdrawn too soon to be taxed at ordinary income tax rates and possibly hit with a 10% penalty.
5. Consider timing of conversions:
– If you’re under 59½ and may need flexibility, stagger conversions so at least some conversions will clear their 5‑year windows before you need the money.
6. Keep documentation:
– Brokerage statements, Form 1099‑R for conversions, and tax year records to prove start dates and conversion years.
Practical steps — If you inherit an IRA
1. Identify the date of the original owner’s death and the account type (traditional vs. Roth).
2. Determine beneficiary category:
– Spouse? Eligible designated beneficiary? Non‑eligible designated beneficiary subject to 10‑year rule? This determines your options. [IRS Retirement Topics – Beneficiary]
3. For inherited Roths: check whether the Roth satisfied the 5‑year rule at the owner’s date of death. If it did, distributions are generally tax‑free. If not, earnings withdrawn before that 5‑year anniversary are taxable. [IRS Pub. 590‑B]
4. Choose a distribution strategy:
– Spouse: can roll into own IRA and follow normal rules, or treat as beneficiary account.
– Non‑spouse EDBs: may use life‑expectancy payouts.
– Non‑spouse non‑EDBs (most cases post‑SECURE Act): generally must empty the account within 10 years (no RMDs during the decade for many cases).
5. Work with an advisor/tax pro:
– Inherited IRA tax rules are complex and can have major tax consequences. Confirm filing and reporting, and if appropriate, ask for estate plan review.
Examples
– Roth earnings withdrawn early: If you withdraw $10,000 of Roth earnings before meeting the 5‑year rule and you’re in the 24% tax bracket, you could pay $2,400 in tax plus a $1,000 (10%) early‑withdrawal penalty — a total of $3,400, or 34% of the withdrawn earnings. [Investopedia]
– Conversion penalty timing: You convert $50,000 in 2024 from a traditional IRA to a Roth and are under 59½. A 2026 withdrawal of $20,000 of the converted funds would still be within the 5‑year conversion window (2024→2028) and might incur the 10% penalty on amounts attributable to that conversion unless an exception applies.
Common mistakes to avoid
– Assuming age alone qualifies Roth earnings for tax‑free treatment.
– Overlooking that each conversion has its own 5‑year penalty clock.
– Missing the significance of the date of first Roth contribution when calculating the 5‑year period.
– Failing to determine beneficiary status and the decedent’s death date under SECURE Act rules.
Frequently asked questions (brief)
– Can I withdraw Roth contributions anytime? Yes — contributions (your basis) can be withdrawn tax‑ and penalty‑free at any time. [IRS Pub. 590‑B]
– Are Roth conversion withdrawals always tax‑free after five years? The conversion amounts themselves were already taxed at conversion (if taxable), but the 5‑year rule refers to avoiding the 10% early‑withdrawal penalty on converted amounts if you are under 59½. [IRS Pub. 590‑B]
– If I inherit a Roth, when are distributions tax‑free? If the Roth met the 5‑year holding period at the decedent’s death, distributions to beneficiaries are generally tax‑free. If not, earnings withdrawn before the 5‑year mark are taxable. [IRS Pub. 590‑B]
The bottom line
“5‑year rule” can mean different things depending on the context: Roth earnings withdrawal qualification, conversion penalty protection, or payout schedules for inherited IRAs under older rules. For Roth accounts you generally need five taxable years plus a qualifying reason (e.g., age 59½) for earnings to be tax‑free. For conversions, each conversion has a separate five‑year penalty clock. For inherited IRAs, SECURE Act changes (effective 2020) replaced many older stretch and 5‑year rules with a 10‑year rule for many beneficiaries. Because timing and beneficiary status matter, keep careful records and consult a tax or financial advisor before taking distributions.
Sources
– Investopedia. “What Is the 5‑Year Rule?” https://www.investopedia.com/terms/f/fiveyearrule.asp
– Internal Revenue Service. Publication 590‑B, Distributions from Individual Retirement Arrangements (IRAs). (See rules on Roth IRAs, conversions, and beneficiaries.)
– Internal Revenue Service. Retirement Topics – Beneficiary. https://www.irs.gov/retirement-plans/retirement-topics-beneficiary
If you want, I can:
– Help you determine your Roth 5‑year start date from your contribution history, or
– Walk through specific scenarios (your age, conversion years, or beneficiary status) to show likely tax and penalty outcomes.