Start the Clock: Important caveat for Roth 401(k) investors to be aware of in preparing for retirement. (And Why Opening a $1 Roth IRA Might Be a Smart Move).
When planning for retirement, we often talk about contribution limits, income thresholds, and account types—but one rule that flies under the radar is the 5-Year Rule for Roth IRAs. And if you’ve been contributing to a Roth 401(k) but have never opened a Roth IRA, this rule could throw a wrench in your tax-free income strategy in retirement.
The good news? A simple action today—opening a Roth IRA with as little as $1—can start the clock and give you potentially more flexibility later. In this post, we’ll break it all down:
What the 5-Year Rule actually means
How it affects Roth IRAs vs. Roth 401(k)s
And how a tiny step today can potentially lead to major tax savings down the road
The Roth IRA 5-Year Rule: What Is It?
To withdraw earnings from a Roth IRA tax-free (qualified withdrawal), two conditions must be met:
✅ You are at least 59½ years old
✅ Your first Roth IRA account has been open for at least 5 years
The “5-year clock” starts on January 1 of the year you make your first Roth IRA contribution—not the exact date you contribute. So, if you contribute $1 to a Roth IRA on December 31, 2025, your clock is considered to have started on January 1, 2025.
While I usually always love adding a consistent annual contribution to a Roth IRA into a retirement plan, it doesn’t matter how much you contribute. One dollar is enough to start the clock.
Roth 401(k)s vs. Roth IRAs: The Key Difference
Here’s where many people get tripped up: Your Roth 401(k) has its own separate 5-year clock.
That’s right—Roth 401(k)s and Roth IRAs are governed by different rules when it comes to distributions. Even if you’ve had a Roth 401(k) open for 10+ years, that doesn’t count toward your Roth IRA 5-year rule.
So, what happens when you retire and roll your Roth 401(k) into a Roth IRA for consolidation? If you’ve never opened a Roth IRA before, your new IRA inherits a brand new 5-year clock—even if you're already over 59½. That means your earnings (not basis) would be taxable if withdrawn during the five-year period.
Why Opening a Roth IRA with $1 may be a Smart Move
This leads to a smart—and simple—planning strategy: Consider opening a Roth IRA now, even if you only contribute $1.
By doing this:
You start your 5-year clock now
That clock applies to all future Roth IRA accounts
You gain flexibility to roll over a Roth 401(k) later without restarting the clock
Note: There are income limitations for Roth IRA contributions (Phaseout in 2025 for Single Filers: $150,000 - $165,000 Adjusted Gross Income (AGI); Phaseout in 2025 for Married, Filing Jointly: $236,000 - $246,000 AGI. If your AGI exceeds these limits, you cannot contribute to a Roth IRA (directly). However, you’ll see a paragraph below that illustrates using a Roth conversion to start the clock. There are no income limitations on who can process a Roth conversion.
Let’s walk through a hypothetical example to illustrate why this 5-year clock matters.
Example: Meet Susan
Age: 55
Contributes to her Roth 401(k) at work
Plans to retire at 60 and roll her 401(k) into a Roth IRA
Has never opened a Roth IRA
If Susan opens a Roth IRA today with a $1 contribution, her 5-year clock starts in 2025. When she retires at 60 in 2030 and rolls her Roth 401(k) into her IRA, she’ll already have met the 5-year requirement. All earnings are tax-free.
If she waits until retirement to open that Roth IRA, she’ll have to wait until 2035 to qualify for tax-free withdrawals—potentially paying taxes on growth in the meantime.
It’s important to note, with Roth IRAs your basis (contributions) come out first. So, Susan would still be able to withdraw her basis tax-free. It’s the portion of her Roth 401(k) (now Roth IRA) that represents growth that would have to wait until 2030.
What Happens to Your Basis and Earnings in a Roth 401(k) Rollover?
When you roll over a Roth 401(k) into a Roth IRA, the basis (your after-tax contributions) and the earnings (growth on those contributions) transfer over as well. The IRS treats the money the same way it was treated in the 401(k): the basis remains tax-free, while the earnings are subject to the Roth IRA’s 5-year aging requirement.
This is where the timing becomes crucial. If you’ve already had a Roth IRA open for 5 years or more, all the earnings from your Roth 401(k)—now sitting inside your Roth IRA—can be withdrawn tax-free (assuming you’re also 59½ or older). But if the Roth IRA is brand new when the rollover happens, you’ll still need to wait until the 5-year clock is satisfied before those earnings become qualified and fully tax-free. That’s why it’s smart to start that clock early, even with a small initial contribution.
Who Should Consider This Strategy?
This strategy is worth considering if:
You’re contributing to a Roth 401(k) but have never opened a Roth IRA
You plan to roll over your Roth 401(k) at retirement
You want to ensure tax-free withdrawals immediately upon retirement
You’re age 50+ and doing long-term planning
Even if you’re younger and still accumulating wealth, opening a Roth IRA now starts the clock early and potentially gives you more future flexibility.
Roth Conversions Also Start the Clock
A Roth conversion (moving money from a Traditional IRA to a Roth IRA) also starts a 5-year clock—but it’s a separate one that applies to each conversion for early withdrawal of principal before 59½. That’s different from the 5-year rule we’re discussing here, which focuses on tax-free earnings withdrawals after 59½.
Please note, Roth conversions are a taxable event. The amount you convert is added to your income in the calendar year you make the conversion and is subject to ordinary income tax. It’s important to have the oversight of an accountant or financial planner when implementing Roth conversions.
✅ Key Takeaways
The 5-year rule is critical for tax-free Roth IRA withdrawals.
Your Roth 401(k) clock does not carry over when you roll into a Roth IRA.
Opening a Roth IRA now (even with $1) starts the clock.
That early clock gives you greater flexibility and potential tax savings in retirement.
📅 Let’s Make Sure Your Roth Strategy Is Designed to Work for You
If you’re not sure whether your Roth IRA clock has started—or how to coordinate Roth contributions, conversions, and rollovers—please feel free to reach out. We can look at your entire financial picture and help assess if this strategy is right for you.
Thanks for reading, and as always, feel free to book a time on my calendar if you want to discuss how we can help with your retirement.
Best regards,
Drew Schaffer, CFP®
Disclosures from Ellis Investment Partners, LLC
Ellis Investment Partners, LLC (EIP) is an investment advisor in Berwyn, PA. EIP is registered with the Securities and Exchange Commission (SEC). Registration of an Investment Adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the commission. EIP only transacts business in states in which it is properly registered or is excluded from registration. A copy of EIP’s current written disclosure brochure filed with the SEC which discusses, among other things, EIP’s business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. The views expressed represent the opinion of Ellis Investment Partners, LLC (EIP) which are subject to change and are not intended as a forecast or guarantee of future results. Stated information is derived from proprietary and nonproprietary sources which have not been independently verified for accuracy or completeness. While EIP believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and management’s view as of the time of these statements. Accordingly, such statements regarding life expectancies, inflation, investment returns, spending in retirement, retirement dates, and retirement planning tips are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Past performance of various investment strategies, sectors, vehicles and indices are not indicative of future results. There is no guarantee that the investment objective will be attained. Results may vary. There is no guarantee that risk can be managed successfully. Investments in securities involve risk, including the possibility for loss of principal.
Additionally, many of the examples provided in this article pertain to tax. This article is not tax advice. Each individual’s tax situation may be different and not reflect the situations illustrated above. Incurring additional income may cause additional taxes or costs. It’s important to work with an experienced tax professional to guide your income and tax decisions.
Any indices and other financial benchmarks shown are provided for illustrative purposes only. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular hedge fund. For example, a hedge fund may typically hold substantially fewer securities than are contained in an index.
Except where otherwise indicated, the information contained in this presentation is based on matters as they exist as of the date of preparation of such material and not as of the date of distribution or any future date. Recipients should not rely on this material in making any future investment decision.
EIP does not provide tax or legal advice. You should seek counsel from your tax or legal adviser for your specific situation. Drew Schaffer is an independent Investment Advisor Representative of Ellis Investment Partners, LLC (EIP). Financial Planning and Investment Advisory Services are offered solely by EIP, a registered Investment Advisor, 920 Cassatt Road, 200 Berwyn Park, Suite 115, Berwyn, PA 19312, 484-320-6300.
Please ensure the disclosure of any material risks of the strategies discussed above.
