Roth 5-Year Rule Explained

Confused about the ROTH Conversion 5-year rule? Have you heard about the 2 5-year rule of the ROTH?
Atty. Chris Berry explains the 5-year rule of ROTH Conversion in this episode of Daily Wisdom.

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Episode Transcript

How to Take Advantage of the Tax-Free Growth

There’s confusion over what that five-year rule is. And the idea is that, the money that you convert over to Roth, needs to stay there. You need not to touch it for five years, to take advantage of the tax-free growth. Now, there’s a second piece of it. So, really, there’s two five-year rules with the Roth. And again, this typically doesn’t become an issue because Roths are typically the last of the money that you would want to touch, because it’s growing in a tax-free environment, but there’s two rules. One is, and a lot of people confuse this. There’s what’s called a Roth contribution. So, that is, while you’re working, you’re contributing to a Roth, and that’s based on your income, whether you can or cannot, and you can contribute anywhere from $6,000 to $7,000 to a Roth. Now, when you’re doing a Roth conversion, the way the five-year rule works is, as soon as you open that Roth.

So, as soon as that Roth IRA is open, that starts the five-year rule. So, if you move money into the… Open a Roth and move money in, in year one, and then you move more money in, in year four, the five-year rule started when you originally opened up the Roth and moved the money in that first time. And so, once you’ve made it five years, you can take the money out of there, and it’s tax free if you want it to. Now, compare that to a Roth conversion. A lot of people, kind of, confuse these big picture, but then, when we’re getting into the details of the five-year rule, it really becomes jumbled. So, a Roth conversion, what you’re doing is, you’re taking money from a pre-tax account, like a IRA, and then you’re moving it over into a Roth, and now it can grow tax-free.


Five-Year Rule

But what you have to do is, you have to pay the tax, right? And the five-year rule, on a conversion, happens each time there’s a conversion. So, think of it as, there’s multiple five-year rules, or five-year time horizons, based on every time you do a conversion. Now, again, we’re, kind of, getting in the weeds in this, and it’s a little, little detail that really doesn’t come into play very often. Because again, if we’re looking at tax buckets and where do you think taxes are going in the future, we have tax-free, tax-deferred and taxable. And so, tax-deferred are your IRA’s, 401k’s, 43B’s, your tax-free, a Roth’s, cash value life insurance, et cetera. If you think taxes are going up, then you probably should prioritize spending down your tax-deferred money first. Second, your taxable. And last, year tax-free money, because we want this tax-free money to take advantage of this tax-free growth.


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