Rules you need to know about Roth IRAs
Give Me Five Rick Moberg | May 21, 2020
ARE YOU PLANNING to withdraw funds from your Roth IRA? If you aren’t careful, you could owe both taxes and penalties, even though you’ve already paid taxes on the money that went into the Roth. At issue: the IRS’s five-year rule. How do you sidestep its unpleasant consequences? Bear with me while I explain.
First, a word of caution: You don’t have to take distributions from your Roth IRA during your lifetime. Withdrawals are strictly up to you. Indeed, it’s a good idea to keep assets in your Roth for as long as possible, so you enjoy a long period of tax-free growth. The five-year rule encourages you to do just that. The rule states that, to avoid income taxes and penalties, you must keep certain assets in your Roth IRA for at least five years.
The five-year period is based on calendar years. The clock starts on Jan. 1 regardless of whether you funded your Roth on Jan. 1 or Dec. 31 of that year. For example, if you made a contribution or a conversion on Dec. 31, you only need to wait just over four years. Your Roth IRA might contain regular annual contributions and conversions from a traditional IRA, as well as the subsequent investment gains earned on these dollars. Think of these as three distinct buckets of money. The five-year rule states that these three buckets come out of your account in a particular sequence—one that actually benefits you.
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Source: Give Me Five – HumbleDollar