Understanding the Five-Year Waiting Period for Converted IRAs

The five-year waiting period for Roth IRAs causes some confusion, because the rules are confusing. 

For a distribution from a Roth IRA to be tax-free, it must be made after the later of the owner’s turning age 59½ and when the owner has had the Roth IRA for at least five years. For distributions from regular Roth IRAs, the five-year period for all regular Roth IRAs of the owner is met if any Roth IRA of the owner has been opened more than five years. 

For converted Roth IRAs, however, there is a separate five-year period for each conversion. If you converted a traditional IRA to a Roth IRA in 2010, you have to wait five years before taking the first tax-free distribution, even if you are over 59½ and had a regular Roth IRA or a different converted Roth IRA more than five years.

But wait, there’s more. Roth IRAs have “ordering rules.” Distributions of less than the entire IRA are assumed to be taken in a certain order. First, distributed are regular contributions. Distributions of converted amounts are next. Only after regular and conversion contributions are distributed are earnings distributed. The ordering rules are important, because only distributions of earnings are taxed. Distributions of regular and conversion contributions are not taxed. You avoid taxes on a distribution until your entire converted amount is distributed.

RW March 2014.