The Roth IRA is an Individual Retirement Account that allows you to invest after-tax dollars that grow tax-free with tax-free withdrawals in retirement. You can also open a joint-account with your spouse. Like a Traditional IRA, the contribution limit is $6000 per year ($7000 if you are over 50 years old). If you withdraw your funds early, you can be subject to a 10% penalty and income taxes. That is unless you follow the rules of 5’s.
The 5-year Rule’s
1. Withdrawing your Earnings
Unlike any other retirement account, you can withdraw your contributions tax-free and penalty-free at any time. You can also withdraw your earnings IF you have held a Roth IRA for at least five tax years. It does not need to be with the same Roth IRA account. You can have a Roth IRA with M1 Finance for 1 year and Betterment for 4 years if you want. Or you can have a Roth IRA with Wealthfront for 5 years, then switch to M1 Finance afterwards. Your five years do not reset when you rollover to a new Roth IRA or open a 2nd or 3rd IRA account. When you are 591/2 years old, you can withdraw your contributions and earnings tax-free and penalty-free as long as you had a Roth IRA open for at least five tax years.
2. Roth Conversions
When you roll-over from a Traditional IRA to a Roth IRA, you have to pay taxes on your traditional IRA funds, however, your converted assets will begin a new five year period before you can withdraw them penalty-free. If you later rollover another Traditional IRA or 401k, you need to start another five-year clock for those assets. The 5-year clock is based on the tax years, not the actual five years. For example, if you start in June of tax year 2021, you can withdraw your earnings as early as January 2026. You don’t have to wait until June 2026.
3. Roth IRA Beneficiaries
Roth IRA’s are one of the best retirement accounts for beneficiaries. If you want to set your child or spouse as a beneficiary, they will get your Roth IRA after you pass away and they will be able to withdraw your contributions and earnings tax-free and penalty-free as long as you held the account for five tax years when you were alive. Roth IRA “Beneficiaries” have to take minimum required distributions. As the beneficiary, you can get a full payout that much be completed within 10 years of the original account holder’s death, or you can take a distribution every year for 5 years. If you don’t deplete the IRA by December 31st of that fifth year, you will have to pay a 50% penalty on the remaining balance. This is a relatively new law that was passed under the 2019 SECURE Act and it only applies to beneficiaries who received the Roth IRA in 2020 or later.
Exceptions to the 5-year Rules
If needed, you can withdraw up to $10,000 of your earnings at ANY time to pay for your first home, health insurance premiums, unemployment costs, medical expenses that exceed 10% of your adjusted gross income, or higher education for you or your direct family members.
How to open a Roth IRA
There are several hundred options out there. Traditional and Roth IRA’s are accessible to every U.S. citizen. Most people are happy to open a Roth IRA with a robo-advisor like Betterment or Wealthfront. These are smart money managers that look at your total net worth, retirement goals, and income to give you advice on building your wealth. They only charge 0.25% APY, or $25 for every $10,000 invested and they offer checking and saving-alternative accounts. Read my full review of Betterment or sign up through my referral link with Betterment or Wealthfront below to get $5000 managed free for a year.
An alternative to Betterment and Wealthfront is M1 Finance and Webull. M1 Finance is a semi-robot advisor. You can choose from their expert made retirement portfolio’s and set a recurring deposit, or you can create your own custom portfolio and regularly buy and sell stocks or ETF’s with your Roth IRA. Read my full review on M1 Finance here. If you choose to join M1 Finance through my referral link below, you will get $30 when you fund your brokerage account $100 (Roth IRA $500) within the first 30 days. This is a limited time offer. Webull, a popular investing brokerage for day trading and intermediate investors, recently started offering Roth and Traditional IRA’s. Unlike M1 Finance, Webull allows you to options trade and buy and sell individual stocks multiple times each day. When you sign up with Webull and fund your brokerage account $100, you get 4 free stocks.
Affiliate Link Notice: This post contains affiliate links, which means I may earn a small commission at no additional cost to you if you decide to purchase or sign up for a product through my referral links. While you can sign up through any other means, it would help support the blog if you sign up through my links. Thanks.
