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5 Key Roth Retirement Account Rules You Should Know

Got questions about the ins and outs of using a Roth retirement account? Money Girl will clear your confusion with answers to listener questions about the Roth five-year rule, who qualifies for a Roth, and more.

By
Laura Adams, MBA,
Episode #591
5 Key Roth Retirement Rules You Should Know

5 Things You Should Know About Roth Retirement Accounts 

1. You can withdraw original Roth contributions without penalty.

Besides tax-free income in retirement, one of the best parts about having a Roth is the ability to tap it before retirement without paying an early withdrawal penalty. This is why a Roth is often used for non-retirement goals such as paying for college, buying a home, or starting a business.

With other types of retirement accounts you must reach age 59½ before withdrawals are penalty-free. But note that this only applies to your original Roth contributions. That’s because you previously paid tax on that portion of funds in your account.  

2. You must own a Roth for five years to withdraw earnings tax-free.

If you want to withdraw the earnings from your Roth, there are some key rules to know. The most important is that if you’re younger than 59½, you must pay income tax plus an additional 10% early withdrawal penalty on the earnings portion of a distribution.

Also, even if you’re older than 59½, you must have owned your Roth for at least five years for an earnings withdrawal to be penalty-free.

3. Roth rollovers don’t change the five-year rule.

Now, let’s get to Debra’s question about rolling over a Roth 401(k) to a Roth IRA. This would be an option after leaving an employer for any reason, such as being fired or quitting. Once you’re no longer employed, you could transfer funds from a Roth 401(k) into a Roth IRA without triggering any tax consequences.

But what can trip you up is not understanding that the five-year rule applies to the account receiving the rollover funds, not the old account. In other words, if you open a brand-new Roth IRA to accommodate your rollover, you’re at day one of the five-year holding period—even if you made contributions to the old Roth 401(k) for decades.

However, if you already have a Roth IRA and use it for a rollover from a Roth account at work, its age counts toward the holding period. So, if it’s three years old, you’d have to wait two more years to pass the ownership test for taking withdrawals that are penalty-free. And if you’ve already owned a Roth IRA for five years and use it for a rollover, you pass the ownership test.

So, if you have a Roth 401(k) or Roth 403(b) and don’t already have a Roth IRA, go ahead and open one. That will start the clock ticking and reduce the likelihood that you’d ever get held up by a waiting period.

So, if you have a Roth 401(k) or Roth 403(b) and don’t already have a Roth IRA, go ahead and open one. That will start the clock ticking and reduce the likelihood that you’d ever get held up by a waiting period.

Otherwise you could be over 59½ and still not qualify to withdraw the earnings portion of your Roth IRA without paying an additional 10% penalty.

When you’re ready to open a Roth IRA, it’s as easy as opening a bank account. You complete an application and transfer funds to activate the account. Look for a company that offers the kinds of retirement investments that you want to make, offers free investment advice and gives you simple options.

The minimum amount you need to open an IRA is typically small, such as $50 or $100. Once it’s open and funded you don’t have to put in another penny. Simply having a Roth IRA in your name counts toward the five-year requirement.

Now, if you lose your job or decide to leave your employer, you can roll over Roth funds into an already-established Roth IRA.

For a summary of rules for using different retirement accounts, download the free Retirement Account Comparison Chart. This handy resource spells out everything you need to know on a one-page PDF.

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