Yes, Roth IRAs can work in your interests from a tax planning perspective but working out how to receive these advantages while also adhering to IRS rules in relation to the 5-year rule can be a difficult question and is just one of the many reasons why it is a good idea to seek cross-border tax and retirement planning advice in this regard.
The Five-Year Rule
The five-year rule requires you to hold your account for five years before you can make withdrawals without incurring penalty. However, it is important to draw a distinction here between withdrawals of contributions and investment earnings: because you have already paid tax on the money, you can withdraw contributions at any point; earnings, however, are likely to be subject to tax.
If you make a withdrawal of earnings, you may be liable for both taxes and a 10% penalty. If you are unsure whether your earnings fall within the five-year period or not, consider this: the five-year period begins on the first day of the year on which you made your first contribution to your Roth IRA. Additionally, you must be aged 59½ or older in order to make a tax-free withdrawal.
Conversions and the five-year rule
Similarly, if you wish to convert a traditional IRA or 401(k) into a Roth IRA, you must also meet the criteria of the five-year rule. For these purposes the five-year period begins on the first day of the year in which you made the conversion. For example, if you converted your 401(k) into a Roth IRA in April 2019, your Roth IRA is treated as beginning on January 1 of the same year. Furthermore, every conversion you make is subject to a separate five-year period.
Beneficiaries and the five-year rule
The five-year rule also applies to any distributions made from the deceased IRA holder’s account to their beneficiaries. However, it is only taxes and not penalties that apply to early withdrawals in these cases.
Non-Residents in the US and Roth Withdrawals
Like everyone else in the US, if you meet the stipulated requirements for a distribution – i.e. you are over 59 ½ and are not subject to the five-year penalty – your Roth distribution is not included in your taxable US income. However, it is important to remember that, depending on whether a tax treaty applies, your country of residence could still levy tax the distribution.
In cases where you are compelled to take early distribution, you will be taxed and penalised on the account’s growth together with any company contributions, but not on your original contributions.
Blacktower (US) LLC
Blacktower (US) LLC can help you make sense of your retirement planning options, including Roth IRAs, 401(k)s and international pension transfers.
For more information about how we can help you both optimise your wealth and comply with the rules of the Internal Revenue Service (IRS), contact our financial advice team today.
We are not tax advisers and independent tax advice should be sought.
The information included here is based on our understanding of the tax benefits at the time of publication.
The above does not constitute advice. You need to seek independent financial advice to ensure the suitability of these solutions.
This communication is for informational purposes only and is not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.
Investment advice and investment advisory services offered and provided through Blacktower Financial Management US, LLC. This communication is for informational purposes only based on our understanding of current legislation and practices which are subject to change and are not intended to constitute, and should not be construed as, investment advice, tax advice, tax recommendations, investment recommendations or investment research. You should seek advice from a professional before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.