Summary
The Roth IRA five year rules affect your tax status of the distribution taken from the Roth IRA. The 5 year rule depends on the age, the time of distribution or any transaction regarding the conversion.
Understanding the Roth IRA five year rule
There are many people out there who are interested in knowing what exactly is Roth IRA five year rule and how to follow them? Actually the Roth IRA five year rule is the five year holding period of the funds. So what is the holding period? The holding period means the maturation date. This means that once you have opened and fund the Roth iRA account, your time starts. Now five years later, your account is in agreement with the set Roth IRA five year rule. This gives you a right to enjoy all the advantages provided by the Roth IRA five year rules.
Not 5 actual years
This means that if you have opened the Roth account of the tax year and also funded it is the day that actually starts your 5 year rule. So whatever month you start your account, the clock begins only in January. If you open an account on December, 2009, the clock will only start in January 2009 and not in the month of December 2009. This way you complete the five year rule only in January 2014. Now even if you make a contribution on March 15, 2010, that contribution is made for the year 2009, which is also done prior to April 15th, which is the tax filling closing date. So if you have funded and opened the Roth in its actual year 2010, January 2009, is the tax year, in which the Roth 5 year rule starts. This is so because the contribution is made towards the tax year of 2009.
Benefits of the 5 year rule
Suppose one is in his 20s and has just opened a Roth IRA account, then the above distinction will not matter, but for those who have reached 55 or are older, it does matter as it can save thousands of dollars and worries. For those who do not pay heed, it would cost them around 10% penalty and income taxes on early withdrawals.