Understanding the 5-year rule with a Roth IRA
A Roth IRA is one of the most attractive retirement plans on the market. It allows the owner to make regular contributions from taxed income toward a retirement fund that is then tax-free upon withdrawal. As with most investment programs, there are some restrictions and requirements when it comes to making withdrawals from the account. The Roth IRA five-year rule is just one of them.
How does a Roth IRA actually work?
A Roth IRA is a retirement account that allows contributors to pay into it using post-tax income. When it comes time to withdraw money from the Roth IRA, those funds are not taxed.
The longer the owner makes those annual contributions and postpones withdrawing the funds, the more money they accrue. With more in their retirement fund, the better off they’ll be in retirement.
What is the five-year rule for a Roth IRA, exactly?
The five-year rule for a Roth IRA is one of those rules placed on an owner’s ability to withdraw funds. Essentially, the contributor has to own the Roth IRA for five years in order to withdraw the earnings and have them be tax-free.
In other words, for an owner to withdraw funds that are tax and penalty free, they must be 59 1/2 years old and have owned the account for five years before the date of withdrawal.
When do the five years technically begin for a Roth IRA?
The good news is that the IRS counts by tax years and not specific dates. This means that the owner who opened their account in 2015 cannot withdraw the earnings from the Roth IRA until January 1, 2020.
Owners who withdraw on the earnings before the five years face a 10% penalty on the amount, plus they must pay income taxes on it. It’s better for owners of a Roth IRA to follow the five-year rule and get the most out of their money.