How long you must wait to make penalty-free withdrawals after converting to a Roth IRA

The timing of converting money from a traditional IRA to a Roth can affect how long you must wait before you’re allowed to withdraw money without penalty.

  • By Brendan Pedersen,
  • Kiplinger
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Q: I've seen several articles about the need to own a Roth IRA for five years to avoid a penalty on withdrawals. But what if you convert a regular IRA to a Roth? Does the five-year period start at the conversion, when you opened the regular IRA, or something else?

A: Once a conversion is done, the IRS’s rules on avoiding Roth withdrawal penalties can be a bit tricky to keep track of. Unfortunately, converting accounts doesn’t help you avoid one of a Roth IRA’s major trade-offs: the five-year rule.

The rule is simple: In order to withdraw money penalty-free from a retirement account you’ve converted into a Roth IRA, you have to wait five years from the start of the tax year in which you made the conversion. In practice, that means if you convert a regular IRA to a Roth IRA in January 2020, you’ll need to wait until January 2025 to avoid penalties. But depending on when you convert your account, you may not need to wait a full 60 months. If you convert an account in December 2020, the finish line doesn’t move: You’ll still need to wait until January 2025, which means having 11 fewer months to count down from.

That’s straightforward enough, but what if you have multiple retirement accounts? Say you inherit an account from a distant relative or start accruing more accounts as your income rises. “The thing to be mindful of is that each conversion is subject to its own five-year rule,” says Mike Giefer, a certified financial planner and wealth manager with Creative Planning in Minneapolis. “Lots of people may systematically convert IRAs over multiple years, and the clock resets for each tax year.” If you converted one account in the final week of December and another in the first week of January, the latter will be subject to withdrawal penalties for an extra year.

If you’ve realized you haven’t been keeping track, don’t panic quite yet: Roth IRAs assume that withdrawals come from your contributions first, followed by any converted dollars and then earnings, says Giefer. In other words, if you’ve converted and moved IRA dollars to an existing Roth account that has already passed the five-year mark, the clock doesn’t reset for the entire balance.

Despite the five-year rule, converting a traditional retirement account to a Roth IRA is a great way to reap the benefit of tax-free withdrawals and an especially good idea if you expect your tax rate to be higher in retirement (although you may owe taxes on some or all of the amount when you convert it).

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© 2019 The Kiplinger Washington Editors, Inc.
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