My RMDs Start Soon So I Want to Convert $900k to a Roth, but I'm Getting Conflicting Info About Having to Wait 5 Years to Use the Money

People with Roth IRAs generally have to wait five years before withdrawing earnings from their account.

But the devil is in the details, and for this particular rule, getting those details can be surprisingly difficult. For starters, the IRS has three different five-year rules that apply to Roth IRAs. One of them, the conversion rule, appears self-contradictory. The IRS doesn't publish clear instructions on these rules. And each outlet writing about this subject appears to give slightly different information.

In other words, don't blame yourself if you're confused. This one is very confusing, which is why working with a financial advisor who understands the ins and outs of the IRS rules can be so helpful. Connect with a fiduciary advisor today.

For example, say you're 70 years old and your required minimum distributions (RMDs) will start in three years. You'd like to avoid RMDs by converting your $900,000 pre-tax savings into a Roth IRA. How will the five-year rule apply?

The Three Five-Year Rules

There are three different versions of the five-year rule, each based on how you fund or receive your Roth portfolio.

1. Roth Contributions

This version applies to earnings from contributions, meaning earned income subject to the annual IRA contribution limit. You must wait five years from when you first fund a Roth account before taking distributions from any Roth portfolio. This is a one-time rule, meaning that it does not reset for any future contributions after your first.

2. Roth Conversions

This version applies to converted balances, meaning assets transferred from a pre-tax portfolio. After you make a conversion, you must wait five years before taking distributions from the converted funds. However, this rule doesn’t apply to people ages 59 ½ and older.

This rule applies independently to each conversion, with the clock starting on Jan. 1 of the year in which you make the conversion. So, for example, if you did a Roth conversion on July 15, 2023, the five-year period would run from Jan. 1, 2023, until Jan. 1, 2028.

Remember, a financial advisor can help you complete a Roth conversion, which can be especially helpful if you’re not eligible to contribute to a Roth IRA directly.

Roth Inheritance

When you inherit a Roth portfolio, depending on your beneficiary status, you may be required to withdraw all assets within five years of the original owner's death. This version applies to inheritances and is beyond the scope of this article.

What Is A Roth IRA?

A Roth IRA is a retirement account funded with after-tax dollars. This means you’ve already paid taxes on the money in the portfolio. As a result, later in life, you can withdraw this money (principal and returns) entirely tax-free. Since the money has already been taxed, Roth IRAs are not subject to RMDs.

There are two ways to fund a Roth IRA: contributions to one directly and converting tax-deferred assets into Roth assets. With a contribution, you invest earned income in your portfolio up to the annual contribution limit ($7,000 per year in 2024). With a conversion, you transfer money from a pre-tax portfolio into a Roth IRA and pay income taxes on the money. There is no limit to how often you can convert assets or in what amounts.

If you need help deciding how to split your retirement savings between tax-deferred and Roth accounts, consider speaking with a financial advisor.

What Is a Qualified Distribution?

A qualified distribution is when you take a tax-free withdrawal of your Roth portfolio's earnings. If your withdrawal does not meet the rules for a qualified distribution, then the IRS will charge you both income tax and a 10% penalty. Since you have already paid taxes on the portfolio's principal, you can withdraw it at any time (Of course, this only applies to direct contributions, not Roth conversions.)

In general to take a qualified distribution you must:

• Be 59 ½ or older OR have a qualifying disability OR meet the first home buyer requirement, AND

• Meet the portfolio's five-year rule

The Five-Year Rule for Conversions

Remember, the five-year conversion rule applies to money that you transfer from a pre-tax account into a Roth IRA.

To recap, you must wait at least five years from when you converted the funds before taking a qualified distribution from those assets. This rule applies separately to each conversion. In practice, each time you convert assets into a Roth IRA you must treat that conversion as its own segment of assets, which must remain in place for five years.

However, the conversion rule does not apply if you’re 59 ½ and older. In that case you may take qualified distributions at any time and avoid the 10% early withdrawal penalty.

This is the rule that applies to our hypothetical example from above: you’re 70 years old and have RMDs starting soon. You would like to convert your $900,000 pre-tax portfolio to a Roth IRA to avoid RMDs. If you find yourself in a similar situation and need help planning your Roth conversions, consider speaking with a financial advisor.

Here are two conversion options and how the five-year rule would come into play:

Lump-Sum Conversion at Age 70+

In this case, you convert all $900,000 in one lump sum. This would trigger about $288,000 in federal taxes, leaving you with about $612,000 in your Roth IRA.

You would be free to begin taking qualified distributions from this portfolio immediately. Even though it has been less than five years, you are older than 59 ½ so the conversion rule does not apply.

Staggered Conversions Starting at Age 70

In this case, you might convert $300,000 per year. This would potentially allow you to avoid RMDs, while also reducing your taxes. You could end up paying about $72,000 per year, or $216,000 in total federal taxes on this conversion.

You would be free to begin taking qualified distributions from this portfolio and its earnings immediately. Even though it has been less than five years, again you are older than 59 ½ so the conversion rule does not apply.

Bottom Line

If you plan to execute a Roth conversion to avoid RMDs, you’ll have to understand how the various five-year rules work. One of those rules is specifically related to Roth conversions, dictating that you must wait five years before being eligible to withdraw converted funds tax- and penalty-free. Fortunately, if you’re 59 ½ or older, this five-year rule doesn’t apply.

Tips On Managing Your RMDs

• Before making any decisions around your required minimum distributions, first you should calculate what they are. To help you do that, SmartAsset built an RMD calculator that will estimate how much your first mandatory withdrawal will be and when it’s due.

• A financial advisor can help you build a comprehensive retirement plan that takes your RMDs into account. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

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