The five-year rule is one of the most misunderstood parts of Roth conversions. Here is exactly how it works and how to avoid penalties.
How does the 5-year rule work for conversions?
When you convert traditional IRA money to a Roth, that converted amount must remain in the Roth for five tax years before you can withdraw the principal penalty-free, if you are under age 59 1/2. The clock starts on January 1 of the year you convert, even if you convert in December, which can shave nearly a year off the wait. Crucially, each conversion has its own five-year clock. Withdraw a converted amount too early and under 59 1/2, and you may owe a 10% early-withdrawal penalty on the converted dollars, even though you already paid income tax at conversion.
Does the 5-year rule apply if I am over 59 1/2?
Largely, no penalty applies once you are 59 1/2 or older. The 10% early-withdrawal penalty that the conversion five-year rule guards against generally does not apply after that age, so most retirees can access converted principal without that concern. There is a separate five-year rule for tax-free treatment of earnings, which begins with your first Roth contribution. For retirees doing conversions in their 60s, the conversion penalty clock is usually a non-issue, but the rules are nuanced. Call 1-800-MEDIGAP at 1-800-633-4427 to coordinate retirement timing, and confirm specifics with a tax professional.