5-Year Rule: Definition for Roth, Traditional, and Inherited IRAs

What Is the 5-Year Rule?

The 5-year rule commonly refers to the withdrawal of funds from an Individual Retirement Account (IRA), but there are other types of 5-year rules. Learn more about the various definitions of a "5-year rule" and how they may apply to you.

How the 5-Year Rule Works

You can withdraw contributions to a Roth IRA at any time. However, to withdraw earnings from your Roth without owing taxes or penalties, you have to have held the account for at least five years, which is the "5-year rule" old. (You must also be at least 59½.)

The 5-year rule only limits when you can withdraw your earnings from your Roth IRA, not your deposits. Your earnings include the interest, dividends, capital gains, and any other income your Roth investments have accumulated. You can withdraw contributions at any time because they were made with money that has already be subject to income tax.

Another type of "5-year rule" applies when you convert a traditional IRA to a Roth IRA. You'll need to wait five years to do with with no penalties. Each conversion has its own five-year period, but IRS rules stipulate the oldest conversions are withdrawn first. The order of withdrawals for Roth IRAs are: contributions, conversions, and then earnings.

If you break the 5-year rule by withdrawing earnings or converting funds from a Roth IRA too soon, your withdrawal will be subject to taxes at your current ordinary income tax rate, plus a 10% penalty.

This can be a large additional tax: If you were in the 24% tax bracket, you would lose 34% of your Roth IRA’s earnings evaporate in taxes and penalties because you withdrew the earnings before five years.

Inherited IRAs vs. Traditional IRAs vs. Roth IRAs

Inherited IRAs

The 5-year rule applies to one of several options when beneficiaries take distributions from an inherited IRA if the death of the account holder occurred before 2020. Whether it's a traditional IRA or a Roth IRA, heirs are required to take annual allocations from the account, known as required minimum distributions (RMDs).

Beneficiaries who inherit an IRA can take distributions of either contributions or earnings without a penalty. However, this distribution may trigger a taxable event, depending upon the type of IRA you inherit and your relationship to the deceased.

If the IRA wasn't held for five tax years by the original owner, and you take a distribution, any earnings or interest on the contribution will be subject to tax.

With the passage of the SECURE Act, starting in 2020, non-spousal beneficiaries of an IRA must withdraw all funds from the account within 10 years of the original owner's death.

Eligible designated beneficiaries such as spouses, beneficiaries who are not 10 years younger than the decedent, a minor child of the plan participant, a disabled person, or a chronically ill person, have more flexibility under the SECURE Act. They can transfer the existing IRA into their name and defer distributions.

Traditional IRAs

Under the 5-year rule, the beneficiary of a traditional IRA will not face the usual 10% withdrawal penalty on any distribution, even if they make it before they are 59½. Income taxes will be due, however, on the funds, at the beneficiary's regular tax rate.

The new owner of the IRA may roll all funds over into another account under their name, cash it out in a lump sum, or a combination. Within the five-year window, recipients may continue to contribute to the inherited IRA account. When those five years are up, however, the beneficiary would have to withdraw all assets.

Roth IRAs 

A Roth IRA is also subject to a five-year inheritance rule. The beneficiary must liquidate the entire value of the inherited IRA by Dec. 31 of the fifth year after the owner’s death. No RMDs are required during this five-year period.

If the beneficiary is taking distributions from an inherited Roth IRA that has existed for longer than five years, all distributions will be tax-free. Further, the tax-free distribution may be made up of earnings or principal. For beneficiaries of a fund that hasn't met that five-year mark, withdrawals of earnings are taxable, but the principal remains untaxed.

Frequently Asked Questions (FAQs)

The Bottom Line

A "5-year rule" can apply to a number of situations, but is most commonly used when referring to how you withdraw funds from an IRA. For guidance on the best ways to withdraw money from your tax advantaged account, consider consulting with a financial advisor.