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Ask an Advisor: If I Convert to Roth Before 73, Does the 5-Year Rule Still Affect My Beneficiary?

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I want to do three Roth conversions in the next three years before I turn 73 in 2027 so that my beneficiary doesn’t have to deal with taxes. If I should die soon after the last conversion, will my beneficiary be subject to the five-year rules?

– Tom

This is a good question. The five-year rules are a regular source of confusion. We field a lot of questions about them in this column. The good news is the answer is clear in this case: No, your beneficiary does not have to worry about the five-year conversion rule. Let’s take a closer look at the five-year rules and the rules for beneficiaries.

Have retirement planning questions? Connect with a fiduciary financial advisor and see how they can potentially help.

First, let’s address the fact that there are two five-year rules for Roth IRAs: One that only needs to be satisfied once and another that applies to each individual Roth conversion.

The first five year rule dictates that in order for a Roth IRA distribution to be qualified, you must have opened and maintained a Roth IRA for at least five years (in addition to being 59 ½ or older). You only have to satisfy this rule once in your lifetime. After that, it’s met for all future Roth IRAs and contributions to them. Withdrawing investment earnings before the five-year period has elapse will trigger a 10% early withdrawal penalty, even if you’re 59 ½ or older.

The second rule applies specifically to Roth conversions. Tom, you are correct that a separate five-year waiting period applies to each Roth conversion.

If someone does a Roth conversion this year and they’re under 59 ½ years old, five years must elapse before they can withdraw the money tax- and penalty-free. If they do another Roth conversion next year it will have its own five year cooling off period.

However, the rule doesn’t apply if you’re 59 ½ or older. (And if you need help navigating the five-year rules, speak with a financial advisor.)

A Roth conversion is a common retirement-planning strategy that can help you forgo RMDs and potentially save money on taxes.
A Roth conversion is a common retirement-planning strategy that can help you forgo RMDs and potentially save money on taxes.

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Each five-year rule has a different purpose and I think understanding them can help you remember when each rule will apply. It also may be helpful to preface this discussion with a reminder that you can always withdraw your own contributions to a Roth IRA tax and penalty free – any time, for any reason, at any age.

The first rule relates to whether or not you can withdraw the earnings tax-free. So, assume you contribute $7,000 to a Roth IRA, and it grows to $8,000 within the first three years. You have $1,000 of gain. If this is your first Roth IRA (and you therefore haven’t satisfied the first five-year rule), you’ll have to pay income tax on that $1,000 if you withdraw it. This is true regardless of your age. Even if you are 59 ½ or older, this rule must be satisfied to qualify for tax-free withdrawals of investment gains.

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