22 Feb How does the Roth conversion 5-year rule work if you die?

Q. If you convert to a Roth IRA and have gains, and you die within the first five years, what happens?
— Need help

A. There are a lot of rules that govern how IRAs work.

Your mention of five years has to do with a provision that’s important to understand.

The five-year rule for Roth conversions exists to prevent people from using conversions to completely avoid the 10% early withdrawal penalty on traditional IRA assets by simply first converting those assets to a Roth IRA and then completing a distribution from the Roth IRA, said Brian Schiess, a certified financial planner with Modera Wealth Management in Westwood.

“Typically, Roth principal would be penalty-free and thus, the five-year rule for Roth conversions requires that converted Roth principal will be subject to the 10% penalty unless five tax years have passed since the conversion,” he said. “The key phrase is tax years.”

If a conversion is completed in December of 2021, it is actually deemed to have occurred as of January 1, 2021, so the actual waiting period from the time of conversion may be less than five years or 60 months. However, each new conversion does start its own five-year clock, Schiess said.

There are several exceptions to this rule, the primary being when you reach age 59 ½.

If you are over age 59 ½ the 10% penalty for distributions of converted Roth principal does not apply, even if it has been less than five years since the conversion, Schiess said.

Another notable exception to the 10% early withdrawal penalty is death, he said. Beneficiaries of Roth IRAs will be able to take distributions of both principal and earnings penalty-free even if the five-year Roth conversion rule has not been met.

However, death does not serve as an exception to the five-year Roth contribution rule, which is separate from the five-year Roth conversion rule, Schiess said.

“For Roth earnings to be tax-free, five tax years must have passed since the original direct contribution has been made to any of the individual’s Roth IRAs,” he said. “For example, if the original owner did not maintain Roth IRA assets for at least five years, distributed earnings would be taxable to the beneficiaries until five years have passed from when the original owner initially established and funded a Roth account.”

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This story was originally published on Feb. 22, 2022.

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