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.

What Are the 5-Year Rules?

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.)

What’s the Purpose of the 5-Year Rules?

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

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.

The five-year rule associated with Roth conversions is meant to prevent those who are under 59 ½ from circumventing the 10% early withdrawal penalty.

Imagine this scenario in the absence of the five-year conversion rule: Suppose you are 50 and have $25,000 in a traditional IRA that you’d like to withdraw. You are free to do so of course, but in addition to regular income tax you’ll have to pay an extra 10% because you’re withdrawing earnings early. Instead, you convert it to a Roth IRA and then immediately withdraw it. Sure, the conversion is subject to income tax, but you would circumvent the 10% penalty because you can always withdraw your contributions from a Roth tax and penalty free.

The five year conversion rule specifically closes this loophole. To be considered a “qualified” withdrawal – one not subject to taxes or penalties – this rule must be met after a conversion.

(And if you need help planning your Roth conversions and withdrawals, consider working with a financial advisor.)

Is Your Beneficiary Subject to the 10% Early Withdrawal Penalty?

A 70-year-old man reviews his IRA balance and plans a series of Roth conversions.

So, here’s where your specific question comes into play. The five-year rule for Roth conversions determines whether you are subject to a 10% early withdrawal penalty. You personally don’t have to worry about the five-year conversion rule because you are over 59 ½ and the early withdrawal penalty simply no longer applies to you.

The same is true for your beneficiary, even if they are under 59 ½. That’s because beneficiary IRAs are categorically not subject to the 10% early withdrawal penalty.

Bottom Line

The five-year conversion rule exists to prevent IRA owners from circumventing the 10% early withdrawal penalty. However, this rule doesn’t apply if you are 59 ½ or older. Additionally, beneficiaries who inherited converted IRAs don’t need to worry about each of the conversion periods because the 10% early withdrawal penalty doesn’t apply to inherited IRAs.

Retirement Planning Tips

Market downturns early in retirement can deplete savings faster. To mitigate this, consider a “bucket strategy,” allocating funds across different time horizons –
cash for short-term needs, bonds for mid-term and equities for long-term growth. Alternatively, using a dynamic withdrawal strategy can adjust spending based on market performance, reducing the risk of running out of money.
A financial advisor can help guide you through the retirement planning process and decide whether Roth conversions are an appropriate course of action to take. 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.

Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.

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