09 Mar What does the 5-year rule mean for my converted Roth IRA?

Q. I did a SEP-IRA conversion in March 2021 to a Roth IRA and I was over 59 1/2 at the time. Do I have to wait five years to withdraw any of the money? I did a separate conversion in January 2022, so how does the five-year rule apply? I converted $4 million in all and my cost basis was around $600,000. I’ve had the Roth open for more than 20 years.
— Retiring soon

A. The conversions must have given you a heck of a tax bill.

But now, you have a sizable pot of tax-free retirement money.

IRAs, including Roth IRAs, are meant to finance your retirement. That is why the 10% early withdrawal penalty was created, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

“The penalty is intended to keep someone from dipping into a retirement account before they retire,” he said. “So if you make a withdrawal from an IRA prior to age 59½ you will have to pay the 10% penalty.”

As you noted, Roth IRAs also have a five-year rule.

This rule says you must pay a 10% penalty if you make a non-qualified distribution from a Roth IRA. A non-qualified distribution is defined as a distribution made before the five-year period beginning with the first tax year for which a contribution was made to a Roth IRA, Kiely said.

There are a few exceptions to the five-year rule.

“One of them is if the withdrawal was made on or after the date you reach age 59½,” Kiely said. “So in your case, the 10% penalty does not apply because you are over age 59½.”

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This story was originally published on March 9, 2022.

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