Ask an Advisor: Convert $700k to Roth Before RMDs—Wait 5 Years?

Understanding Roth IRA Withdrawal Rules

As a 68-year-old retiree with approximately $1.4 million in retirement accounts, including $1.2 million in a Traditional IRA and $110,000 in a Roth IRA, you’re likely looking to optimize your financial strategy as you approach retirement. You also receive about $47,000 annually in Social Security benefits, and your Required Minimum Distributions (RMDs) are set to begin in 2027. To prepare for this, you and your financial advisor are considering making annual Roth conversions before 2027.

This plan sounds promising, but you’ve encountered conflicting information regarding when you’ll be able to make withdrawals from the Roth IRA. Your advisor suggests that you must wait five years after each Roth conversion before withdrawing any funds, including both the converted amount and any earnings. However, others have told you that since you are over 59 ½, you can withdraw the converted amount without any waiting period. This confusion is understandable, as Roth IRA withdrawal rules can be complex.

Key Roth IRA Withdrawal Rules

To clarify, there are specific IRS rules governing when you can withdraw money from a Roth IRA. These rules are often referred to as the “five-year rules.” There are two main rules: one for Roth IRAs and another for Roth conversions.

5-Year Rule for Roth IRAs

The first five-year rule applies to Roth IRAs that were funded directly by contributions. This rule states that you must wait five years after your initial contribution to a Roth IRA before you can make tax-free withdrawals of investment earnings. The five-year period begins on January 1 of the year in which your first contribution was made.

For example, if you made your first contribution in November 2020, the five-year period started on January 1, 2020. Therefore, you could start withdrawing earnings tax-free after January 1, 2025.

However, simply meeting the five-year rule isn’t enough. Withdrawals must also be “qualified” to avoid taxes and penalties. One common way to qualify is to reach age 59 ½. If you meet this age requirement, you can withdraw earnings tax-free at any time, provided the five-year rule has been satisfied.

In your case, since you opened your Roth IRA in 2015 and are over 59 ½, you have already met both requirements. This means you can withdraw any amount from your Roth IRA without incurring taxes or penalties.

5-Year Rule for Roth Conversions

There is also a separate five-year rule for Roth conversions. If you convert funds from a Traditional IRA to a Roth IRA, you must wait five years before withdrawing the converted amount without incurring a 10% early withdrawal penalty. This rule applies to each individual conversion, meaning the five-year clock starts for each conversion separately.

However, because you are over 59 ½, this rule does not apply to you. You are automatically exempt from the 10% penalty on withdrawals from a converted Roth IRA.

What Does This Mean for Your Situation?

If you were to make a $75,000 Roth conversion in 2024, the five-year rule would still apply to that specific conversion. This means you would need to wait until 2029 before being able to withdraw the converted amount without incurring a penalty. However, the original $60,000 in contributions to your Roth IRA (established in 2015) is already eligible for tax-free withdrawal at any time, since you are over 59 ½ and the five-year rule has already been satisfied.

Therefore, while the $75,000 conversion would require a five-year waiting period, the existing contributions in your Roth IRA are available for immediate withdrawal without penalty or tax liability.

Tips for Managing Your Roth IRA

If you're considering Roth conversions or managing your retirement accounts, it’s important to understand the rules thoroughly. Here are some tips to help you navigate this process:

• Consult a Financial Advisor: A qualified financial advisor can help you develop a personalized retirement strategy and guide you through the complexities of Roth conversions.
• Keep an Emergency Fund: Maintain a liquid emergency fund in a high-interest savings account to cover unexpected expenses without disrupting your retirement plans.
• Review Your RMDs: As your RMDs approach, ensure you understand how they will affect your overall financial strategy.
• Stay Informed: Regularly review IRS guidelines and stay updated on changes to retirement account rules.

By understanding these rules and working with a trusted financial professional, you can make informed decisions that align with your long-term financial goals.