The big lure of the Roth IRA is its potential for tax-free growth. For a Roth IRA withdrawal to be tax-free, it must be a qualified distribution. A qualified distribution is one which passes two tests including the five-year rule. (Learn about the other test for qualified Roth distributions and the tax treatment of nonqualified distributions).
Five Years Might Not Be Required to Pass the Five-Year Rule
The five-year clock starts as of the first day of the year to which you designate your first Roth IRA contribution. Since you can contribute to a Roth IRA as late as your tax return filing deadline, it’s theoretically possible to meet the five-year requirement in less than four years.
The Five Year Rule - Example 1
Steven first contributes to a Roth IRA on November 10, 2005. The contribution is for the 2005 tax year. Since the first day of the 2005 tax year is January 1, 2005, Steven’s five-year rule is satisfied as of January 1, 1010.
The Five Year Rule - Example 2
Jennifer first contributes to her Roth IRA on April 14, 2003, right before her 2002 tax return filing deadline. She designates her IRA contribution as a contribution for 2002. The first day of the 2002 tax year is January 1, 2002. Therefore, Jennifer meets the requirements of the five-year rule on January 1, 2007 even though it’s been less than four years since her first contribution.
Conversions Have Their Own Clock
If you convert a regular IRA to a Roth IRA, you must wait to withdraw earnings on the converted amount for five years or they will be potentially taxable nonqualified distributions.