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Denise Appleby- Author, Speaker on IRAs & Employer Retirement Plans; Consultant, and Trainer of Choice for Financial and Tax Professionals
The Two Roth IRA Five Year Rules and Their Effect on Tax and Penalties
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There are two five-year rules for Roth IRAs. One is used to determine if a distribution is qualified. The other is used to determine how much of a non-qualified distribution is subject to income tax and/or the 10% early distribution penalty. Since a key factor for both is reaching the age 59 ½, we created the following chart to answer the question “How does age 59 ½ affect my Roth IRA distribution?” Let’s take a look. |
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Distributions Before age 59 ½ At this stage, you need to be concerned about income tax and the 10% early distribution penalty that applies to pre-59 ½ distributions. |
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Type of Funding |
Early distribution penalty (10%) [1] |
Income tax |
Comments |
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Regular Roth IRA Contributions |
Does not apply |
Does not apply |
•§ This represents basis and can be taken at anytime, tax and penalty free. No holding period |
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Roth Conversion amounts from other IRAs and rollover amounts from employer plans. |
10% early distribution penalty applies, unless: •§ The conversion amount has been in a Roth for at least five years, or •§ An exception to the 10% penalty applies |
Does not apply |
•§ Each conversion has its own separate five year holding period. •§ Older conversion amounts are distributed first. So, a conversion made in 2008 is distributed before a conversion made in 2009 •§ If the distribution is qualified[2], you stop counting this five year period, because it is no longer relevant |
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Earnings |
Yes. Unless an exception to the 10% penalty applies |
Yes. Unless the distribution is qualified. |
•§ See footnote for definition of qualified distribution |
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Distributions on or after age 59 ½ At this age, you need to be concerned only about income tax. The 10% early distribution penalty cannot apply, because the owner has already reached age 59 ½. |
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Type of Funding |
Early distribution penalty (10%) |
Income tax |
•§ Comments |
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Regular Roth IRA Contributions |
Does not apply |
Does not apply |
•§ This represents basis and can be taken at anytime, tax and penalty free. No holding period |
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Roth Conversion amounts |
Does not apply |
Does not apply |
•§ The five year holding period that applies to conversion amounts do not apply because the owner is at least age 59 ½ |
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Earnings |
Does not apply |
Yes. Unless the distribution is qualified. |
•§ No penalty applies, because the owner is at least age 59 ½. •§ Income tax applies, unless the distribution is qualified. |
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This is only one approach to understanding the tax and penalty impact of distributions from Roth IRAs. This is demonstrated in our Roth Tax and Penalty Quick Reference Guide.
[1] Early Distribution penalty Exception: The 10% penalty does not apply under any circumstances, if the individual is at least age 59 ½ when the distribution occurs, or if any of the exceptions apply. See our early distribution penalty quick reference guide for a list of the exceptions.
[2] Qualified Distribution Defined: A qualified distribution is one that meets the two following requirements: (1) It is taken at least five years after the individual funded his first Roth IRA. This five year period never starts over. And (2)One of the following applies at the time of the distribution: (a) The individual was at least age 59 ½ at the time of the distribution (b) The distribution was used for a first time home ( limit $10,000) (c) The individual was disabled at the time of the distribution, and (d) The distribution was taken after the individual’s death, by his beneficiaries.