#taxfreeinvesting

Actually, there are three five-year rules you need to know about.

The first five-year rule determines when you can begin receiving tax-free qualified distributions from your Roth IRA.  Withdrawals from your Roth IRA — including both your contributions and any investment earnings — are completely tax- and penalty-free if you satisfy a five-year holding period and one of the following conditions also applies:

• You’ve reached age 59½ by the time of the withdrawal
• The withdrawal is made due to a qualifying disability
• The withdrawal is made for first-time homebuyer expenses ($10,000 lifetime limit)
• The withdrawal is made by your beneficiary or estate after your death

This five-year holding period begins on January 1 of the tax year for which you made your first contribution (regular or rollover) to any Roth IRA you own. For example, if you make your first Roth IRA contribution in March 2022 and designate it as a 2021 contribution, your five-year holding period begins on January 1, 2021 (and ends on December 31, 2025). You have only one five-year holding period for determining whether distributions from any Roth IRA you own are tax-free qualified distributions (Roth IRAs you inherit are subject to different rules).

The second five-year rule is a little more complicated. When you convert a traditional IRA to a Roth IRA, the amount you convert (except for any after-tax contributions you’ve made) is subject to income tax in the year of the conversion. However, your conversion isn’t subject to the 10% early distribution penalty, even if you haven’t yet reached age 59½.

But what the IRS giveth it can also taketh away. If you withdraw any portion of your taxable conversion within five years, you’ll have to pay the 10% early-distribution penalty on those funds that previously avoided the tax — unless you’ve reached age 59½ or qualify for another exemption from the penalty tax. This five-year holding period starts on January 1 of the year you convert your traditional IRA to a Roth IRA. And if you have more than one conversion, each will have its own separate five-year holding period for this purpose.

The third five-year rule applies to In-Plan Roth’s (i.e., Roth 401k or Roth 403b). While it’s similar to the five-year rule that applies to Roth IRAs, there are important differences. Learn more here about Roth’s in retirement plans.

Withdrawals from your Roth 401(k) plan account — including both your contributions and any investment earnings — are completely tax- and penalty-free if you satisfy a five-year holding period and one of the following conditions also applies:

• You’ve reached age 59½
• You have a qualifying disability
• The withdrawal is made by your beneficiary or estate after your death

(Note: There is no first-time home buyer exception for a Roth 401k).

The five-year holding period begins on the first day of the calendar year in which you make your first Roth 401(k) contribution (regular or rollover) to the plan. For example, if you make your first Roth contribution to your company’s 401(k) plan in December 2022, your five-year holding period begins on January 1, 2022, and ends on December 31, 2026.

If you participate in 401(k) plans maintained by different employers, your five-year holding period is determined separately for each plan. But there’s an important exception. If you make a direct rollover of Roth dollars from your prior employer’s plan to your new employer’s plan, your five-year holding period for the new plan will be deemed to start with the year you made your first Roth contribution to the prior plan.

For example, Beth made Roth contributions to the Acme 401(k) plan beginning in 2018. In 2022, she changed jobs and began making Roth contributions to the Beacon 401(k) plan. Her five-year holding period for the Acme plan began on January 1, 2018, and ends on December 31, 2022. Her five-year holding period for the Beacon plan began on January 1, 2022, and ends on December 31, 2026. In 2022, Beth decides to make a direct rollover of her Acme Roth account to Beacon’s 401(k) plan. Because of the rollover, Beth’s January 1, 2018, starting date at Acme will carry over to the Beacon plan, and any distributions she receives from her Beacon Roth account after 2022 (rather than after 2026) will be tax free (assuming she’s at least age 59½ or disabled at the time of distribution).

There are many rules you must be aware of when establishing a Roth, completing a rollover, or when doing a Roth conversion. If you’d like to learn more about retirement planning strategies using Roth retirement accounts, feel free to Talk With Us!

Prepared by Broadridge Advisor Solutions. Edited by BFSG. Copyright 2022.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Crystal Kessler, CFP®, Wealth Advisor/Financial Planner

There is a lot of confusion when it comes to In-Plan Roth’s (i.e., Roth 401k or Roth 403b) and a Roth IRA. Throughout this article we will refer to just Roth 401ks but know the rules we refer to for Roth 401ks apply to other In-Plan Roth’s like 403bs. It is important to realize that these are two completely different investment vehicles, and they both have very different rules when it comes to eligibility and contributions.

First off, it helps to know the difference between Traditional vs. Roth. It mostly boils down to when you pay your taxes -now or later. With a Traditional Retirement Plan (i.e., 401k or 403b) or Traditional IRA (Individual Retirement Account), you make contributions with pre-tax dollars, and you get a tax break up front, thus helping to lower your current taxable income. Both contributions and earnings grow tax-deferred, meaning you do not pay taxes on it, until you withdraw it. With a Roth 401k or Roth IRA, it’s basically the reverse. You make your contributions with after-tax dollars, meaning there’s no upfront tax deduction and your income taxes are paid on that money before it goes into the account. Due to this, both the contributions and earnings grow tax free, and any withdrawals are tax free after you reach age 59 ½ (*withdrawals are tax free provided they are made at least 5 years after the first Roth contribution was made).

A Roth 401k is an employer sponsored retirement plan where an individual makes contributions directly from their paycheck to their company sponsored retirement account. Most employer plans give you the option to make your employee contributions to a Traditional 401k or a Roth 401k.

A Roth IRA is an account one can open at any investment firm and contribute to as long as they have earned income. However, there are income limitations to Roth IRAs when it comes to being able to contribute. To make a full contribution to a Roth IRA, as a single filer you must make less than $125,000 for 2021 ($129,000 for 2022). For married filing jointly, the combined income must be less than $198,000 for 2021 ($204,000 in 2022). The maximum contribution limit is $6,000 a year. However, there is a $1,000 catch-up contribution if you are over the age of 50. This allows an individual to contribute up to $7,000 if he or she is over the age of 50. If you are married and make less than the income limit, each spouse can make a full contribution to each of their Roth IRAs.

Example: If Jack (age 53) and Jill (age 54) file married, jointly and make less than $198,000 combined income in 2021 then Jack can contribute $7,000 to his Roth IRA and Jill can contribute $7,000 to her Roth IRA by April 18th, 2022, since they are both over age 50 and made less than the income limit set for 2021.

Most of the confusion with Roth 401k’s centers around if individuals can contribute to them because they see “Roth” and assume that if they make too much money then they can’t contribute to it. That is very wrong when it comes to Roth’s in retirement plans. Most employees are eligible for a Roth 401k and can contribute to it as long as their employer offers it in their retirement plan. A Roth 401k has no income limit whatsoever. The only limitation a Roth 401k has, is the plan’s contribution limit. For 2022 employees can contribute up to $20,500, and anyone over the age of 50 can make an additional catch-up contribution of $6,500. What is important to consider when contributing to a Roth 401k is the fact that you will be taxed on your income before you contribute to the Roth 401k, but the contributions and earnings grow tax free within the Roth 401k.

Example: Let’s look at Jack (age 53) and Jill (age 54) who file married, jointly and make $325,000 combined taxable income in 2022. Although they make too much to contribute to a Roth IRA, they can still contribute to a Roth 401k. Let’s say Jack maxes out his Roth 401k for the year, and because he is over age 50, he can make a maximum contribution, due to the catch up, of $27,000. He will be taxed on that $27,000 at their marginal tax bracket of 24%, but that full $27,000 will be contributed to the Roth 401k and grow tax free. Come retirement when Jack and Jill take distributions from the account it will all be income tax free. Another big difference between a Roth 401k and Roth IRA, is that Roth 401k accounts are subject to required minimum distributions. You are required to start taking tax-free withdrawals at age 72 from an Roth 401k. Roth IRA’s do not have this required minimum distribution requirement. However, you can rollover your Roth 401k account to a Roth IRA before age 72 and avoid the required minimum distributions.

* Withdrawals are tax free provided they are made at least 5 years after the first Roth contribution was made.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.