How to Navigate Roth IRA 5 Year Rule

June 6, 2011 - PRLog -- As you have probably heard, in order to take tax-free distributions from your Roth IRA, you must reach two milestones:

  1. Be over the age of 59 1/2
  2. Have had one Roth IRA open for five years or more

But how do you really navigate these two important rules? We'll give you an example.

Let's say you opened your first Roth IRA on April 10, 2007 at the age of 60. The clock for income-tax-free distributions will start on January 1, 2007; the year you first established a Roth IRA.  This date will apply to all future Roth IRA contributions and conversions in all Roth accounts that you have.

Since you are already over the age of 59 ½, you must wait until 2012 (2007 + 5 = 2012) until you can take earnings out of the account income-tax-free.

That bears repeating: you must wait five years until you can take EARNINGS out of the account income tax free if you are over the age of 59 1/2.

What does that mean? You can take tax-free distributions from the account before 2012.  The first money out of a Roth IRA is:

   * contributions; then when they are exhausted:
   * conversions are distributed; and when they are exhausted, then:
   * earnings are distributed

Since income tax was already paid on both the contributions and the converted amounts when they go into the Roth IRA, they can be distributed income tax free at any time, even before the five-year holding period is up.

The final lesson here is that you would benefit greatly to keep close track of what amount in your Roth IRA is from annual contributions, what amount is from conversions, and what amount is from earnings. As long as you keep track of those, you will know exactly how much you can distribute from your Roth IRA tax free before your five year waiting period. And then, once that milestone is up, you no longer need to keep such close tabs!

Please note: this is for informational purposes only and should not be construed as tax advice. Please consult a tax advisor.

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RBFMS was founded by brothers Dave and John Richmond in 1994. Over its seventeen years in business, the company has evolved into a proactive wealth management firm focusing on retirement distribution planning. A $500M, privately-owned operation, RBFMS has helped hundreds of clients realize their retirement goals. The company is located in Jackson, Michigan and is currently able to service clients in the states of MI, AZ, CA, FL, GA, IA, IN, KS, KY, CO, MN, NC, NY, OH, TX. Securities are offered through Sammons Securities Company, LLC Member FINRA/SIPC. Fee based investment advisory services are offered through Sigma Planning Corporation, a registered investment advisor.