The Roth IRA 5-Year Rule

By Elsie Dudukovich2 Comments

There are many reasons why saving for retirement can be a challenge.  For some, it is the thought of having their money “tied up” in an IRA, unavailable until they turn 591/2.  After all, shouldn’t we all have an emergency fund that can handle at least six months of expenses?  A quick glance at Investopedia’s recommendation for a solid six month cash reserve shows you should sock away $24,054.48 if your household income is $48,109.

That can be a lot of money to set aside for a rainy day, but when it pours you’ll be glad it’s there.

If you spend any time watching the news, you also know most Americans don’t have enough saved for retirement.  With company pensions more of a relic than land lines, you need an IRA and should also take advantage of a 401(k) or similar plan your employer offers, if you can.

The current IRA contribution limits allow someone to contribute 100 percent of their compensation up to $5,500 if they are age 49 and under (if you’re 50 and older, you can contribute an additional $1,000).

$5,500 (or $6,500) a year can also be a lot of money to save… but when you need it you’ll be glad it’s there as well.

For someone trying to do the best they can for their financial future, managing to fund an emergency fund and an IRA can be more than a bit daunting.  What if you could do both at the same time?

Enter the Roth IRA. (Read more here or watch this video!)

With a Roth IRA, you can withdraw your contributions tax- and penalty-free once the account’s been open for five years. 

If eligible, a Roth conversion can be a way to bring more funds than your contribution limit allows to your Roth IRA.  However, you will also have a five-year waiting period on the converted funds before you can withdraw tax and penalty free.  Each time you do a conversion from your traditional IRA to your Roth account, the funds will have a five-year waiting period.  If you do three conversions on three different dates from your traditional IRA to your Roth, you will have three five-year waiting periods.     

As with all things related to your taxes, diligent record keeping is in your best interest.  If you decide you need to withdraw a portion of your contributions, you need to be sure of how much you contributed and when, in order to avoid the possible taxes and penalties associated with a premature distribution. 

Keeping your prior 5498 forms can save you some headaches, as this form is used by your custodian to report contributions to the IRS for the tax year.  Your accountant or tax preparer can assist you with filing IRS form 8606 to offset the IRS form 1099-R associated with an IRA distribution, as well as offering any guidance you might need in determining how much in contributions you may take. 

The Roth IRA is a truly valuable tool for people of any age.  If you or someone you care about needs to save for life’s emergencies as well as having a plan for their golden years, contact a Senior Account Executive today and ask how the Roth IRA could potentially help you plan for the future.