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5-Year Rule

The 5-Year Rule for Individual Retirement Accounts (IRAs) refers to a set of guidelines that determine how and when you can withdraw earnings from a Roth IRA without penalties. Here’s a brief overview:

  1. Roth IRA Contributions: With a Roth IRA, you contribute after-tax dollars, which means you can withdraw your contributions (but not the earnings on those investments) at any time without taxes or penalties.
  2. Earnings Withdrawals: To withdraw the earnings (the growth or interest your contributions have made) without penalties, two criteria must be met. First, the Roth IRA must have been opened at least five years before. Second, the withdrawal must be made for a qualified reason, like reaching age 59½, becoming disabled, or being a first-time homebuyer.
  3. 5-Year Rule for Roth Conversions: If you’ve converted a traditional IRA to a Roth IRA, each conversion has its own 5-year period before earnings can be withdrawn tax and penalty-free. This rule applies regardless of your age, even if you’re over 59½.
  4. Beneficiaries and the 5-Year Rule: If you inherit a Roth IRA, different rules apply. Beneficiaries must either withdraw all the funds within five years of the original owner’s death or take distributions over their lifetime, a rule that changed under the SECURE Act of 2019.
  5. Importance of Compliance: Complying with the 5-Year Rule is crucial to avoid unnecessary taxes and penalties. It’s a key consideration in retirement planning, especially when deciding between Roth and traditional IRAs or when considering Roth conversions.

It’s always advisable to consult with a financial advisor or tax professional to understand how these rules apply to your specific situation, as IRA regulations can be complex and change over time.