How does the 5-year roth rule work?

The 5-year rule on Roth conversions requires that you wait five years before withdrawing any converted balance, contribution or profit, regardless of your age. If you withdraw money before the end of five years, you'll have to pay a 10% penalty when you file your tax return. The Roth Individual Retirement Account (IRA) is a retirement savings instrument that allows you to make tax-free withdrawals if you follow the rules. The 5-year Roth IRA rule states that it takes five years for them to be deposited in a Roth IRA account.

This means that you can't withdraw any of the profits from your tax-free IRA contributions until five years have elapsed since January 1 of the tax year in which you first contributed to the account. Your earnings would be comprised of dividends, capital gains, interest, and any other type of return you have received on Roth IRA financial assets. This rule for Roth IRA distributions stipulates that five years must have elapsed since the tax year of your first contribution to the Roth IRA before you can withdraw profits from the account tax-free. On the other hand, under Treasury Regulation 1408A-10, Q&A-4 (a), for a Roth IRA what counts is the original 5-year Roth IRA rule.

If Jeremy converts his IRA into a Roth IRA, he'll also need to declare the amount as ordinary income; however, he can now withdraw his after-tax capital from his Roth IRA (the conversion amount) without an early withdrawal penalty.