5-Year Rule for Roth IRA Conversions

Submitted by Chung-Chu Hsieh on Sat, 2023-03-18 23:15

An account holder (who was older than 59 and 1/2 years old) did not have any Roth IRA until he did a back-door Roth IRA conversion in 2022. Need guidance on the following questions:

1) The 5-year rule on Roth conversions requires an account holder to wait 5 years before withdrawing any converted balances (contributions or earnings) – regardless of the age? If the account holder takes money out before the five years is up, will he/she have to pay a 10% penalty when filing tax return?

2) If a withdrawal is taken before 5 years (and without qualifying for an exceptions), are the withdrawn principals or earnings taxable?

3) As the earnings (e.g., dividends and interests) could be realized at different times during the 5-year period, how to account and track them for this rule? Do the earnings have different 5-year clocks based on their record dates?

4) Each Roth IRA conversion has its own five-year holding period to avoid an early withdrawal penalty. All Roth IRAs of the account holder are treated as one for the purposes of withdrawal rules. Advices for managing multiple Roth IRA conversions done over multiple years to avoid 5-year rule penalties and taxes?

Thank you.

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Permalink Submitted by Alan - IRA critic on Sat, 2023-03-18 23:31

No. The 5 year holding requirement for conversions does not apply after 59.5.
Earnings would be taxable, but they come out last. Therefore, any amount up to the converted amount could be withdrawn anytime without tax or penalty.
There is only one 5 year clock here, the one that expires on 1/1/2027. After that the entire Roth will be qualified and tax and penalty free. Before that, only the converted amount can be withdrawn tax and penalty free. If more than the converted amount is withdrawn before 2027, tax will be owed on the excess but no penalty.
There is never a tax on distributions of conversions, just for the conversion itself. If conversions are done prior to 59.5, whether to separate Roths or into a single Roth account, they must be tracked by year as the oldest year’s conversions come out first. Any regular Roth contributions all come out before any conversions. This is all reported on Form 8606, but the Roth owner must keep track of the balance of regular contributions and conversions to fill out Form 8606. Once any Roth is qualified, all Roths are qualified and the tracking can be forgotten. Form 8606 is not required once the Roth is qualified.