Roth retirement accounts have a 5-year rule, but the rules are slightly different for a Roth IRA and a Roth 401k (or Roth solo 401k).
The Roth IRA lets you withdraw your contributions from your account at any age without penalty, even if you’re not 59½ years of age yet. To withdraw earnings from your account, you must be at least 59½ years old AND your account must have been active for at least 5 years.
The Roth 401k or Roth solo 401k also has a 5 year withdrawal rule. However, you’re not allowed to take out your contributions at any age, without penalties, like you can with a Roth IRA. To withdraw contributions and/or earnings from a Roth 401k or Roth solo 401k, you must be at least 59½ years old AND your account must be at least 5 years old.
The 5 year rule can get especially tricky when considering rollovers and conversions. Here’s everything you need to know about the 5-year rules for Roth retirement accounts.
When does the 5 year clock start?
The 5 year clock starts on January 1st, the year you make your first contribution to your account. It does not start when you open your account, you must make your first contribution in order for the 5 year clock to start ticking.
For example, if you open your account in 2020, but you make your first contribution in June of 2021, the clock would start on January 1st of 2021 and would end on December 31 of 2026.
When can I withdraw from a Roth IRA without penalties?
You can withdraw your contributions from a Roth IRA without penalties at any time, regardless of your age. Only the Roth IRA allows you to do this, you cannot withdraw contributions from a Roth 401k or Roth solo 401k.
To withdraw your earnings, you must be at least 59½ years old and your account must have been active for at least 5 years.
For example, if you make your first Roth IRA contribution at the age of 58, you’ll have to wait until your 63 years old in order to make withdrawals of your earnings without any penalties.
When can I withdraw from a Roth 401k without penalties?
With a Roth 401k, contributions cannot be withdrawn at any time like with the Roth IRA. To make withdrawals of contributions and earnings without penalties, you must be at least 59½ years old, and your account must be at least 5 years old.
When can I withdraw from a Roth solo 401k without penalties?
The Roth solo 401k has the same rules as a regular Roth 401k. You cannot take contributions out at any age. To withdraw contributions and earnings from your account, you must be at least 59½ years old, and your account must have been active for at least 5 years.
What are the penalties for breaking the 5 year rule?
Early withdrawals are hit with a 10% early distribution penalty plus income taxes on the amount drawn.
The 5 year rule penalty is waived if you pass away or become disabled. You’re also allowed to take out up to $10,000 for the purchase of your first home without penalties.
There are other exceptions where the IRS lets you make early withdrawals without penalties:
- Unreimbursed medical bills
- Health insurance premiums (if you were unemployed for at least 12 weeks)
- If you owe the IRS
- Higher education expenses for yourself, spouse, children, grandchildren, or immediate family members
- Money needed to prevent eviction or foreclosure
Rollovers, conversions, and the 5-year rule
Another question people have is what happens to the 5 year rule when you do a rollover from another account or conversion.
If you rollover a Roth IRA to a new Roth IRA
Rolling over a Roth IRA to a new Roth IRA does not reset the 5 year clock. The time passed in your old Roth IRA will carry over into the new Roth IRA. For example, if you had your Roth IRA for 3 years, rolling it over to a new Roth IRA would still be considered 3 years old.
If you rollover a Roth 401k to a Roth IRA
If you received a Roth 401k at work, that’s now over 5 years old, but want to rollover the funds to a Roth IRA, the holding period for your Roth 401k is lost and will use the 5-year clock of the Roth IRA instead.
If you rollover a Roth 401k to a new Roth 401k
Let’s say you received a Roth 401k dating back 3 years ago at your old your employer and found a new job that also offers a Roth 401k. The 3 year holding period of the old account can be carried over to the new Roth 401k ONLY IF you do a direct rollover. If you choose an indirect rollover (also known as a 60-day rollover), the old holding period would instead be reset and counted as a new Roth 401k.
If you convert a traditional IRA to a Roth IRA
If you convert a traditional IRA to a new Roth IRA, the conversion would count as starting the 5 year clock even though it’s not a contribution. For example, if you convert a traditional IRA to a new Roth IRA in June of 2020, the 5 year clock would start on January 1, 2020.
Also read: Roth IRA vs Traditional IRA
What is a Roth retirement account?
A Roth retirement account like the Roth IRA, Roth 401k, and Roth solo 401k allow you to make contributions with after-tax dollars. You fund your account with income you’ve already paid taxes on. The advantage of doing this is that qualified distributions in retirement are completely tax-free.
In comparison, a traditional retirement account like the traditional IRA, traditional 401k, and traditional solo 401k allow you to make contributions with pre-tax dollars. Your contributions get deducted from your taxable income. However, qualified distributions in retirement get taxed as regular income.
With a traditional retirement account, you only need to wait until you’re over the age of 59½ in order to start taking qualified distributions without any penalties. With a Roth retirement account, you have to wait until you’re over the age of 59½ and your account must be at least 5 years old.
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