The Five-Year Rules for Roth IRA and Roth 401k Withdrawals  

When it comes to Roth IRAs and Roth 401ks, understanding the "five-year rules" is crucial for making tax-efficient withdrawals. Below, I break down the key points:

Roth IRA Withdrawals

• Direct Contributions: You can withdraw your direct contributions to a Roth IRA at any time, tax-free and penalty-free.
• Qualified Withdrawals of Gains: To withdraw earnings tax-free (qualified withdrawals), two conditions must be met:

• You must be at least 59.5 years old.
• The account must satisfy the five-year rule, meaning five years have passed since your first contribution to any Roth IRA.

The Five-Year Rule: The clock starts with your first contribution to any Roth IRA or Roth Conversion. Once five years have passed since this first contribution, the five-year rule is satisfied for that account.

Roth IRA Conversions

• Separate Five-Year Clocks: Each Roth conversion triggers its own five-year clock. After five years, the converted amount can be withdrawn without penalties. Once you turn 59.5, any converted amounts can be withdrawn penalty-free, regardless of whether the five-year period has passed.

Let's clarify the order of withdrawals from the Roth IRA. IRS states that withdrawals must occur in the following order:

1. First, direct contributions are withdrawn.
2. Next, Roth conversions are withdrawn, starting with the oldest conversion.
3. Finally, any gains are withdrawn.

Note that for tax-free withdrawals of gains, both conditions must hold (age is 59.5+ years old and the five-year rule), while for penalty-free withdrawals of Roth Conversions, one of the conditions must hold (either 59.5+ years old or the five-year clock fired).

Roth 401k Withdrawals and Conversions

• Five-Year Clock for Roth 401ks: Each Roth 401k has its own five-year clock for the tax-free withdrawal of gains. Similarly, each in-plan Roth conversion starts a separate five-year clock for penalty-free withdrawals.

Roth 401k to Roth IRA Rollovers

• Starting a New Clock: If you roll over a Roth 401k into a new Roth IRA, a new five-year clock starts for the Roth IRA, even if the Roth 401k clock was already satisfied. This can be disadvantageous if you are near or over 59.5 years old, so opening a Roth IRA as early as possible is advisable.

Roth 401k to Roth 401k Rollovers

There are following possibilities:

• Partial Transfer: The five-year clock for the new Roth 401k is unaffected.
• Entire Account Transfer: The five-year clock from the old Roth 401k is transferred to the new account, which is generally desirable to avoid restarting the clock.

Notes:

• Starting Early: If you’re 55 or older and haven’t yet contributed to a Roth IRA, consider starting one now to get the five-year clock ticking.
• Strategic Rollovers: Be cautious with rollovers, as they can restart the five-year clock and impact your ability to make penalty-free and tax-free withdrawals.
• Backdoor Roth Contributions: A Backdoor Roth contribution is essentially a Roth conversion, so it follows the same rules as other Roth conversions.
• Mega Backdoor Roth: This strategy, where after-tax 401k contributions are converted to a Roth account, is another form of Roth conversion and follows the same five-year rules for Roth Conversions.