What Are the Roth IRA Holding Period Rules?
Withdrawing from a Roth IRA tax-free involves specific IRS timing rules. Learn how these requirements apply to your funds to ensure you avoid taxes and penalties.
A Roth Individual Retirement Arrangement (IRA) offers the potential for tax-free growth and, eventually, tax-free withdrawals. This means that unlike traditional retirement accounts, the money you take out in retirement is not counted as taxable income. Accessing these tax benefits is contingent upon following specific timing rules established by the Internal Revenue Service (IRS). These regulations, known as holding periods, are designed to ensure the account is used for its intended purpose of long-term savings.
The Five-Year Rule for Contributions
The primary timing regulation for Roth IRAs is the five-year holding period for contributions. This rule applies to the investment earnings within your account, and for any withdrawal of earnings to be tax-free, you must first satisfy this five-year clock. If you withdraw earnings before this period is complete, those earnings may be subject to both income tax and a 10% penalty.
The clock begins on January 1st of the tax year for which you made your very first contribution to any Roth IRA. You can make a contribution for a specific tax year up until the tax filing deadline of the following year, which is usually in April. For example, if you open a Roth IRA and make your first contribution in April 2024 but designate it for the 2023 tax year, your five-year clock is considered to have started on January 1, 2023.
Once this clock has started, it does not restart, even if you open additional Roth IRA accounts. It is a single, permanent clock that applies to you as the account holder, covering all Roth IRAs you own, regardless of your age.
Requirements for a Qualified Distribution
Satisfying the five-year rule for contributions is the first step toward receiving tax-free earnings. For a withdrawal to be considered a “qualified distribution” by the IRS, a second condition must also be met: the withdrawal must be for a specific, IRS-approved reason. Without meeting both the holding period and a qualifying event, any earnings withdrawn are treated as a non-qualified distribution.
The four main events that allow for a qualified distribution are:
- Reaching age 59½.
- The death of the account owner, which allows the beneficiary to take distributions.
- An account holder who becomes totally and permanently disabled.
- A first-time home purchase, which allows for a lifetime maximum withdrawal of $10,000 from earnings.
Both conditions must be met simultaneously. For example, if an individual withdraws earnings after holding the account for ten years but is only 50 years old and not disabled, the earnings portion of the withdrawal will be subject to income tax and a potential 10% early withdrawal penalty.
Withdrawal Ordering Rules
The IRS has established a specific order for how money is withdrawn from a Roth IRA. The sequence of withdrawals is not optional and is automatically applied by the financial institution managing the account. This ordering allows you to access certain funds sooner than others without tax consequences.
Withdrawals are always considered to come from three categories of funds in a specific order. First, you withdraw your regular contributions. Since you made these contributions with after-tax money, you can withdraw them at any time, for any reason, completely free of taxes and penalties.
After all of your regular contributions have been withdrawn, the next money to come out is any amount that was converted from a traditional IRA or rolled over from another retirement plan. Only after both contributions and converted amounts are depleted are withdrawals considered to come from investment earnings. For example, if your account holds $30,000 in contributions, $15,000 in conversions, and $5,000 in earnings, a $32,000 withdrawal would consist of all your contributions and $2,000 of your converted funds.
The Separate Five-Year Rule for Conversions
A different five-year holding period applies to funds moved from a traditional IRA or 401(k) into a Roth IRA, an action known as a conversion. This rule is separate from the five-year clock for contributions and exists to prevent individuals from using a Roth conversion as a loophole to avoid the 10% early withdrawal penalty on traditional IRA funds.
Each conversion event starts its own unique five-year clock. This clock begins on January 1st of the calendar year in which the conversion was made. For instance, if you convert funds from a traditional IRA to a Roth IRA in June 2024, the five-year holding period for those specific converted funds begins on January 1, 2024.
If you are under age 59½ and withdraw the principal (the converted amount) from that conversion before its five-year clock is complete, that portion of the withdrawal will be subject to a 10% penalty. For example, if a 45-year-old converts $50,000 and then withdraws that $50,000 in the third year, the 10% penalty would apply.