Q&A: Nuts and Bolts of Five-Year Rule on Roth IRAs - WSJ.com

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Focus on Retirement - By KELLY GREENE

Q: Could you explain how the five-year rule for Roth IRA conversions works and how it differs from the five-year rule for contributions to Roths?

Do multiple conversions over a period of time trigger a new five-year waiting period for each conversion?

Does attaining age 59½ have an effect?

—Stephen Turbin, North Miami, Fla.

A: For withdrawals to be penalty free, the five-year rule governing Roth IRAs for the most part works the same for people who open and begin periodic contributions to a Roth IRA and those who convert to a Roth from a traditional individual retirement account or other retirement plan. But as with all things involving IRAs, there is a wrinkle or two.

Let's start with the person who opens a Roth and makes periodic contributions. That person can withdraw those original contributions anytime with no tax or penalty. The five-year clock for earnings on those contributions starts January 1 of the year for which your first Roth contribution was made, and it doesn't reset each time you make a contribution or open another Roth. You have to turn 59½ to avoid a 10% penalty for early withdrawals on any earnings, and also to avoid income tax on those earnings.

As for the person who converts to a Roth: In a conversion, you have to hold the assets in a Roth for five years or until turning 59½, whichever comes first, to make penalty-free withdrawals of your converted amounts. Here, each conversion has its own five-year clock.

If you already are 59½ and you convert traditional IRA assets to a Roth, you can withdraw the assets you convert at any time without worrying about a five-year deadline or penalties.

Again, it is a different story with any earnings on those assets: You have to have held a Roth account for five years to withdraw any earnings tax free. But you generally don't need to worry about separating the converted funds from the earnings, since the withdrawal rules for Roth IRAs say that any distributions first come from contributions, then from conversions, and finally from earnings, says Ed Slott, an IRA consultant in Rockville Centre, N.Y.

Rules are spelled out in IRS Publication 590, "Individual Retirement Arrangements," at http://www.irs.gov/. See page 69 under "Ordering Rules for Distributions."

Let's say that 10 years ago, you put $100 into a Roth IRA and now you are 62. That means you have met the age requirement and the five-year-holding requirement for withdrawing your contribution and any earnings with no penalty or tax, Mr. Slott says.

Now, let's say you still have that $100 Roth, and you also convert $100,000 from a traditional IRA to a Roth. (Of course, you pay taxes on the conversion.) You could then withdraw the $100,000 with no tax or penalty, because it is considered to have been held for five years, Mr. Slott says. "The five-year period started the first day you opened that Roth IRA 10 years ago, so you could take out that $100,000 any time."

If you are younger than 59½, though, you could run into trouble: Let's say you're 40 and you opened a Roth 10 years ago with $100. Now you convert $100,000 to a Roth IRA. If you withdraw that $100,000 a year later, at age 41, you owe a 10% penalty on all the converted funds. Even though the account has been open five years, each conversion starts a five-year clock -- until you turn 59½. (You wouldn't owe tax on that amount, though, because it is generally due for the year of the conversion.)

Write to Kelly Greene at kelly.greene@wsj.com

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