The Roth 5 Year Rule Is Really Two Rules

I converted money into a Roth in my thirties and assumed I could take it back out whenever I liked, on the reasoning that Roth money is after tax money and I had already paid the tax.

Two clocks.

There are two five year rules, they measure different things, and nearly every explanation I read at the time treated them as one rule.

Clock one, the contribution clock

It starts on January 1 of the tax year of your first ever contribution to any Roth IRA. You get one of these in your life. It does not restart when you open a second Roth account, and it does not restart if you empty the first one and start again years later.

What it governs is the earnings. Your own contributions can come out at any age, at any time, with no tax and no penalty, because you already paid income tax on that money before it went in.

For the earnings to come out tax free you need the clock finished and a qualifying reason: reaching age 59 and a half, disability, death, or a first home purchase up to a lifetime cap.

Contribute $500 in December and the clock is treated as having started on January 1 of that tax year. A single dollar starts it. If you are eligible and undecided, put in a dollar now, because this is the one clock you cannot start retroactively.

Clock two, the conversion clock

You get one of these per conversion, each starting January 1 of the year that conversion happened. Convert in three different years and you are running three separate counts.

What it governs is the early withdrawal penalty on converted money taken out before its five years are up, and only if you are under 59 and a half at the time.

Say the penalty is 10 per cent. Convert $20,000 at 37, pull it out at 40, and that is $2,000, because 20,000 times 0.10 is 2,000. On money you already paid income tax on when you converted it.

Once you are past 59 and a half this clock stops mattering entirely, which is why people who convert late in life never encounter it.

The order money comes out in

You do not choose. Withdrawals come out in a fixed order: contributions first, then conversions oldest first, then earnings last.

This ordering is usually on your side, because the safest money is at the front of the queue. Someone who has contributed $30,000 over the years can withdraw $30,000 without touching a conversion or an earning, and therefore without touching either clock.

The 401k version is a separate thing

A Roth 401k runs its own five year clock, tied to that plan, and it does not carry across to your IRA. Roll a Roth 401k into a Roth IRA and the IRA's clock is the one that counts.

Which is a quietly good reason to open a Roth IRA years before you have any intention of using it, even with a token amount in it. The clock is running while the account sits there doing nothing.

Find the year you first put money into a Roth IRA and write it somewhere you will still have access to in twenty years, because nobody sends you a reminder and statements get lost in provider migrations.

If you have never opened one and you are eligible, a single dollar this year starts a clock that only runs forward.