Roth IRA Restrictions: How You Can Plan Ahead to Avoid Taxes (or Penalties)

Roth IRA Restrictions: How You Can Plan Ahead to Avoid Taxes (or Penalties)
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(This article originally appeared in the February 2025 issue of Military Officer, a magazine available to all MOAA Premium and Life members. Learn more about the magazine here; learn more about joining MOAA here.)

Roth individual retirement accounts (IRAs) can be a great way to save for retirement because distributions after you reach age 59½ are generally tax-free.

 

Roth IRAs have no obligation for required minimum distributions (RMDs). And because contributions are made with money you’ve already paid taxes on, these IRAs can provide flexibility even before retirement age since you are able to withdraw any contributions you made without penalty or taxes.

 

However, there are several restrictions on Roth IRAs that owners should know about if they want to avoid taxes and/or penalties. The restriction is known as the "Five-Year Rule," but in reality, there are two separate five-year rules to pay attention to.

 

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Five-Year Rule: Withdrawals

This IRS rule states you can withdraw your earnings from your Roth IRA tax-free as long as you have held the account for at least five years. This specifically applies to earnings, since as mentioned above, you can withdraw your contributions at any time.

 

The clock for this rule starts the first time money is deposited into any Roth IRA you own.

 

The five-year period begins on Jan. 1 of the year you made your first contribution, so if you make your first contribution in December, you actually might only have to wait a little over four years.

 

If you don’t wait the full five years before beginning withdrawals, your distributions will be considered nonqualified and you will have to pay taxes at your ordinary income tax rate on your earnings, even if you are age 59½. If you are under age 59½, you will owe a 10% early withdrawal penalty in addition to taxes on your earnings.


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There are a few exceptions to the five-year rule that allow you to make a withdrawal without paying the 10% penalty. These include withdrawals up to $10,000 for the purchase of a first home, if you become permanently and totally disabled, or for educational purposes. However, you would still owe income tax on these distributions.

 

Five-Year Rule: Conversions

The other five-year rule states that you must wait five years before withdrawing balances converted from a traditional IRA to a Roth IRA. Otherwise, you might owe a 10% early withdrawal penalty, which would come on top of the income taxes you already owe from the conversion.

 

Again, the clock for the five-year period begins in January of the year you execute the conversion, no matter when during the year the conversion actually happened. However, each conversion or rollover is subject to a separate five-year holding period.

 

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Those who have passed age 59½ won’t be subject to the 10% penalty on their conversion, but they will need to have had the account open for at least five years to avoid running afoul of the five-year rule mentioned above, which would cause their withdrawals to be taxed.

 

Inherited Roth IRAs

While owners of Roth IRAs don’t need to take RMDs, their beneficiaries must do so.

 

Those RMDs are generally tax-free if they meet the five-year aging rule. If the owner of the IRA had opened it more than five years previously, the beneficiary won’t owe taxes. If the five-year period wasn’t met, the distribution will be included in the beneficiary’s gross income and will be subject to taxes.

 

While Roth IRAs have many benefits, both as a way to save for retirement and to potentially provide a legacy for survivors, it is important to understand the five-year rules that might apply. Otherwise, you, or your heirs, might be in for an unexpected tax bill.

 

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About the Author

Lila Quintiliani, ChFC®, AFC®
Lila Quintiliani, ChFC®, AFC®

Quintiliani is MOAA's Program Director, Financial and Benefits Education/Counseling. She is a former Army Military Intelligence Officer as well as the spouse of an active-duty servicemember, and worked for over a decade at military installations as a personal financial counselor.