The Roth IRA's five-year rule says you can't withdraw tax-free earnings until at least five years have passed since you first contributed to a Roth IRA. This is a broad standard, according to Treasury rules. The five-year period begins when money is deposited into a Roth IRA for the taxpayer. Under this rule, contributions include both direct contributions and converted amounts.
The Roth Individual Retirement Account (IRA) is a retirement savings vehicle that allows you to make tax-free withdrawals if you follow the rules. The Roth IRA's 5-year rule says that it takes five years to be invested in a Roth IRA account. This means that you cannot withdraw any of the earnings from your IRA contributions without paying taxes until five years have elapsed since January 1 of the tax year in which you first contributed to the account. Your earnings would be made up of dividends, capital gains, interest and any other type of return you have received on the financial assets of the Roth IRA.
Inherited Roth IRAs also have their own watch, but it starts with the original owner of the account and when they made their first contributions, not when the person inherited it. You may also qualify for an exception if you are disabled or if you inherit the Roth IRA after your death. Therefore, even if the 5-year rule has already been met for qualified distributions from a Roth IRA, a Roth 401 (k) still has to meet its own 5-year period. Since the IRS wants you to save Roth IRA funds for your retirement, it disapproves of withdrawing them too soon.
You can use your Roth IRA to pay for higher education expenses for yourself, your spouse, a child, or a grandchild. The first five-year rule states that you must wait five years after your first contribution to a Roth IRA to withdraw your earnings tax-free. Roth IRAs are also flexible, giving you greater access to your money than traditional retirement accounts. However, keep in mind that your ability to contribute to a Roth IRA is based on your modified adjusted gross income, or MAGI.
If you inherit a Roth IRA from someone other than your spouse, you have a couple of options for withdrawing funds. There is also a separate five-year rule that applies only to those who convert other types of retirement accounts to Roth IRAs. The Roth IRA rewards those who are willing to accept deferred gratification by not granting you an upfront tax cut, but rather giving you tax-free treatment of your income and earnings, as long as you keep your investments in the account. But the distribution of Roth IRA earnings is taxable, because Max was under 59 and a half years old and did not meet any other test to exempt profits from taxes.
So it's also worth noting that since the 5-year rule for Roth conversions simply leaves the withdrawal of conversion principal potentially subject to the early withdrawal penalty, any other exception to the early withdrawal penalty can still protect the Roth conversion amount from the penalty. This means that if you use the Roth IRA backdoor strategy every year, your Roth contributions are actually conversions and you can't withdraw them for five years without penalty.