Understanding the Five-Year Rule: Essential for Roth Account Rollovers

Navigating the rules around Roth 401(k) rollovers to Roth IRAs can be unexpectedly complicated—even for experienced retirement savers. The interplay between the five-year rule, Roth IRA eligibility, and specific income and contribution limits often leads to confusion and unintended tax consequences. Financial advisors working with retirement plans must be prepared to address these nuances, helping participants understand the distinct timing requirements and strategic options available for optimizing their retirement outcomes.

The Five-Year Rule: Critical Timing

The five-year rule determines when Roth account distributions become tax-free, in addition to the age requirement (59½). The rule operates differently for Roth 401(k)s and Roth IRAs:

• 401(k): The five-year period begins January 1 of the year of the first Roth 401(k) contribution.
• Roth IRA: The five-year clock starts January 1 of the year the individual first opens any Roth IRA.

Each account type runs its own five-year clock. If someone rolls over a Roth 401(k) to a new Roth IRA, the Roth IRA's five-year period starts fresh, potentially delaying access to tax-free earnings. However, if they already have a Roth IRA older than five years, rollover funds can be withdrawn tax-free right away.

Roth IRA Eligibility & 2025 Contribution Limits

To contribute to a Roth IRA, individuals need earned income (not passive income like dividends or rental payments).

2025 Contribution Limits:

• Under age 50: $7,000
• Age 50 or older: $8,000 (includes $1,000 catch-up)

Income phase-out ranges for 2025:

• Single/Head of Household: Full contribution below $150,000 MAGI; phase-out $150,000–$165,000; no contribution above $165,000.
• Married Filing Jointly: Full contribution below $236,000; phase-out $236,000–$246,000; no contribution above $246,000.
• Married Filing Separately: Phase-out $0–$10,000; above $10,000, no contribution.

Those in the phase-out range have reduced contribution room; above the limits, direct contributions aren’t allowed. 

Strategies for High-Income Earners

For individuals above Roth IRA income thresholds:

• Backdoor Roth IRA: Make a nondeductible contribution to a Traditional IRA, then convert to a Roth IRA. There are no income limits for conversions, but taxes may apply on pre-tax IRA assets.
• Mega Backdoor Roth: Some 401(k) plans allow extra after-tax contributions, which can be rolled over to a Roth IRA or Roth 401(k). This requires special plan features and careful tax planning.
• 59½ In-Service Rollover: A participant can roll even a small amount from a Roth 401(k) to a Roth IRA after age 59½, starting the Roth IRA five-year clock.

Smart Planning Tips

To guide participants effectively, advisors should:

• Explain the separate five-year rules for Roth 401(k)s and Roth IRAs and encourage early Roth IRA establishment—even with a small amount—to avoid restarting the clock at rollover.
• Clarify eligibility and contribution/income limits.
• Discuss backdoor and mega backdoor Roth strategies, and in-service distributions.

Proactive education helps participants avoid tax surprises and make the most of their retirement savings.

Mastering the finer points of Roth 401(k) and Roth IRA rollovers demands more than a surface understanding of retirement accounts. For both advisors and savers, proactive education on the five-year rule, contribution thresholds, and advanced planning strategies is key to avoiding tax surprises and unlocking the full benefits of tax-free growth in retirement.