What is the 5 year rule for backdoor Roth IRAs?
5-Year Rule for Roth IRA Conversions
The Internal Revenue Service (IRS) requires a waiting period of 5 years before withdrawing balances converted from a traditional IRA to a Roth IRA, or you may pay a 10% early withdrawal penalty on the conversion amount in addition to the income taxes you pay in the tax year of your conversion.
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account.
Another option, if your employer's plan offers it, is the mega backdoor Roth. Under this option you would make after-tax contributions into your employer's 401(k) plan. For 2024 the limit for these after-tax contributions is $46,000.
Roth IRA conversions come at the cost of having to pay taxes on converted funds now rather than later, however. Also, funds converted after age 60 have to be left in the account for five years before they can be withdrawn tax-free.
Cons: All or part of a backdoor Roth IRA conversion could be a taxable event. You may have to pay federal, state, and local taxes on converted earnings and deductible contributions. Conversions could kick you into a higher tax bracket for the year.
One can reduce or even eliminate pre-tax IRA funds, therefore avoiding the pro-rata rule. Bypassing the pro-rata rule on the Roth conversion portion of the backdoor Roth strategy requires the account owner to have $0 of pre-tax money in all non-Roth IRAs at the end of the year of the conversion (i.e., December 31).
This IRS rule says you can't withdraw your Roth earnings tax-free without owing taxes for at least five years from the beginning of the tax year for which you made your first Roth IRA contribution. This applies even if you are retired and/or older than 59.5.
5-year rule: If a beneficiary is subject to the 5-year rule, They must empty account by the end of the 5th year following the year of the account holders' death. 2020 does not count when determining the 5 years. No withdrawals are required before the end of that 5th year.
When you do a Roth IRA conversion, you must wait five years to withdraw the converted amount to avoid a 10% tax hit. There's a separate five-year waiting period for each conversion; by doing a conversion every year for several years, you create a “ladder.”
Are they getting rid of backdoor Roth?
While it doesn't look like they'll be eliminated in 2024, the future of the Backdoor Roth IRA remains a target of proposed legislation. Some legislative efforts have already been taken to limit Roth IRAs or to change tax brackets and RMDs in the future.
Whether it is worth it to do a backdoor Roth IRA depends on your financial situation. If, for example, you are in the 22% federal marginal income tax bracket (or under), you should do a Roth IRA to diversify your retirement funds. If your federal income tax bracket reaches 24%, you are at a neutral state, more or less.
Some high-profile personal finance commentators are big fans of the “backdoor Roth IRA.” I'm not — at least not for high earners — and here's why: If you're making enough money to be considering a backdoor Roth, there are likely higher-impact, less administration-intensive ways to minimize your tax burden.
Once you turn 59½, you needn't worry about this five-year rule, even if you take a payout before your conversion meets the five-year period. For example, there's no 10% penalty if you do a Roth IRA conversion at age 58 and withdraw funds two years later at age 60.
The 5-year rule regarding Roth IRAs requires a waiting period before you can withdraw earnings or convert funds without a penalty. To withdraw earnings from a Roth IRA without owing taxes or penalties, you must have held the account for at least five tax years.
5-Year Rule Applies
Whether you put money into a backdoor Roth or mega-backdoor Roth, the account must be open for five years before you can withdraw both contributions and earnings tax free.
Mega backdoor Roth conversions can be a 'no brainer' for higher earners, expert says. Roth individual retirement accounts offer tax-free growth and other benefits, but some investors earn too much for direct contributions.
You won't pay double taxes with a backdoor Roth, but you may end up paying some taxes depending on your financial situation. Talk with your financial advisor before making this move to minimize taxes and maximize retirement benefits.
A backdoor Roth can be created by first contributing to a traditional IRA and then immediately converting it to a Roth IRA to avoid paying taxes on any earnings or having earnings that put you over the contribution limit.
A “backdoor” Roth IRA allows high earners to sidestep the Roth IRA's income limits by converting nondeductible traditional IRA contributions to a Roth IRA. That typically requires you to pay income taxes on funds being rolled into the Roth account that have not previously been taxed.
Can you still do a back door Roth in 2024?
Understanding Backdoor Roth IRAs
The limits are as follows: For 2023: Between $138,000 and $153,000 for single filers and between $218,000 and $228,000 for joint filers. For 2024: Between $146,000 and $161,000 for single filers and between $230,000 and $240,000 for married couples filing jointly4.
The IRS does not put a cap on the number of Roth conversions per year you can make. You could convert all of your savings to a Roth IRA in one go or spread them out over several conversions throughout the year. You can also complete Roth IRA conversions in multiple years, which could make sense in certain situations.
Withdrawals must be taken after age 59½. Withdrawals must be taken after a five-year holding period. If you transfer your Traditional or Roth IRA at any age and request that the check be made payable to you, you have up to 60 days to deposit that check into another IRA without taxes or penalties.
Roth Conversions
So by converting your IRA to a Roth, you could avoid having to pay extra income taxes from mandatory IRA withdrawals in retirement. The catch is that you have to pay income taxes on the amount you convert at your ordinary income rate when you convert it.
Inheriting a Roth IRA as a Spouse
You can withdraw contributions at any time. Earnings are taxable until you reach age 59½, and it's been at least five years since your spouse first contributed to the account, the 5-year rule. This option is only available if you're the sole beneficiary.
