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Roth Conversions and the 5-Year Rule


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June 25, 2023

A majority of Americans have their retirement savings in qualified retirement accounts like 401(k)/403(b) plans and Traditional IRAs, and it's no wonder; it's meaningful to take advantage of employer matching and pre-tax contributions, which help save on income taxes in the current year.

There are two major trends underway, however, which will affect Americans' planning considerations in the years ahead.

First, there's a largescale demographic shift in the Baby Boomer generation, which peaked in 1960. An article from the Federal Bank of St. Louis estimates that in 2025, when those born in 1960 will have reached age 65, more than 170,000 people will retire every month. As those retirees enter the work-optional phase of life, they'll be presented with a choice of what to do with the funds they've accumulated in their retirement accounts: how to spend, whether to keep them inside the plan or roll over to Traditional IRAs, and possibly whether to do Roth conversions.

Additionally, the Tax Cuts and Jobs Act (TCJA), which went into law at the beginning of 2018, had a radical - but often overlooked - effect on retirement accounts inherited by non-spouses. Whereas before, a non-spouse beneficiary (like a child or grandchild) could spread RMDs out over their lifetime, helping that account to last in near-perpetuity, they now have to pull it all out within 10 years (5 years for trusts). The IRS sees big dollar signs here, but it's not nearly as favorable for your heirs…

It'll depend on your individual circumstances, but this confluence of factors makes it worth reconsidering the Roth conversion. Especially if you're approaching retirement and in a lower tax bracket than your heirs who may be in their prime working (and tax-paying!) years.

Attention to those considering this, though! You may have heard of the 5-year rule for Roth IRAs, but there are really two separate ones: one for Roth contributions and another for Roth conversions.


In short, your Roth principal (the amount you've contributed) is free for you to withdraw at any point, but the growth may be subject to tax and penalty if you withdraw it before your Roth account has been opened for 5 tax years (if you make a prior year contribution between January 1 and mid-April of the following year, that does count as a contribution for the prior tax year - and thus counts toward the 5 year clock). The IRS aggregates all Roth accounts [ex-Roth 401(k)s!] in calculating this window.


Unlike contributions, each individual conversion starts its own clock for the 5 year window! Something to keep in mind if you do make conversions before your full retirement age. A tip for the wise: if you're at least 59 ½, this is irrelevant, since the IRS allows tax-free Roth withdrawals past that age. (Note that the 5 year contribution rule would still apply!)

It's enough to make your mind spin, but the government put these rules in place to prevent taxpayers from abusing the Roth rules. At any rate, being able to convert pre-tax funds to Roth in the years ahead may be a very wise move if your (and your family's) time horizon justifies it. Roth IRAs are still subject to the 10 year non-spouse inheritance rules, but Roth disbursements - unlike Traditional IRAs - would nonetheless be tax-free to those beneficiaries.

If you or someone you know has been mulling this over, or if this is a new concept that you'd like to explore in more detail, don't hesitate to reach out. We're here to help! Click Here to find out more about Roth Conversions!

Additional Reading: The Roth IRA is 25 Years Old in 2023! Top 5 Reasons to Roll Over Your 401(k) to An IRA

If you would like to receive more information on making smart money moves for your future, be sure to contact us today!


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About the author

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Drew Pond

Wealth Plan Design Specialist

Drew Pond is an independent financial advisor and CFP® Practitioner at oXYGen Financial, specializing in portfolio construction, goals-based planning, life and long-term care insurances, and retirement plans, with 7 years' experience in the financial services industry. He lives in Midtown, Atlanta.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. oXYGen Financial is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice. Investor Disclosures: https://bit.ly/KF-Disclosures

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

Background and qualification information is available at FINRA's BrokerCheck website.

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Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. oXYGen Financial is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice. https://Bit.ly/KF-Disclosures

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