When does the 5-Year Roth IRA Clock Start?
Posted by Chad BordeauxTuesday, January 12th, 2010
I recently fielded the following question from one of our clients:
“I opened my Roth IRA on September 5th, 2005 . Can I withdraw the contributions now or do I have to wait until September 6th 2010 so that they will not be taxable or subject to penalty?”
Qualified distributions from a Roth IRA are not included in the recipients gross income, nor are they subject to the 10% penalty for early withdrawal.
The actual contributions themselves can be withdrawn any time with out tax or penalty. There is a 5-year holding period from the time of the first contribution into a Roth IRA until the time in which you may be able to withdraw the earnings on those funds without being subject to income taxes and a 10% penalty. In addition to satisfying the 5-year rule, in order to avoid the penalty and the tax, you must also satisfy one of the following: (1) the distribution must also occur on or after the date that you become age 59 1/2, (2) at or after your death, (3) the distribution is due to a disability, or (4) in conjunction to a first-time homebuyers purchase (up to $10,000).
Contrary to what one might think, the 5-year clock does not start based on the date that you actually made the contribution, but rather the tax year you made the contribution. The tax code deems all contributions made during a year as made on January 1st of that year. In the above example, the initial contribution is deemed to have been made on January 1st, 2005. Therefore, the taxpayer must wait until January 1, 2010 in order to be able to remove any earnings on those contributions without being subject to the 10% early withdrawal penalty.
The good news is that any withdrawals are first assumed to come from contributions and then earnings. Therefore, no amount is included in gross income until all of the after-tax contributions have been withdrawn. Generally, if an individual receives a distribution of earnings from a Roth IRA that is included in income, they will also be subject to the 10% additional tax for early distributions.
Chad is a Charlotte CPA who works with small business owners and invidiuals on a monthly basis to provide them with proactive guidance and advice on how to grow their business, minimize their tax liabilities and grow their bottom line. You can find our more about Chad by visiting his profile here: Chad BordeauxTags: Retirement, retirement planning, Roth IRA
