Roth IRA Red Flags: 5 Rules Nobody Explains

A listener we'll call Janet opened her first Roth IRA in 2022 and funded it with nothing but annual contributions. In 2026 she turned 60 and pulled out $35,000 to help her daughter with a down payment. Her logic seemed airtight: I'm over 59½. It's my money. It's a Roth. So it's tax-free. She was right on two of those three counts, and the third one cost her about $5,000 in federal and state income tax. Her Roth was only four years old. It hadn't satisfied the five-year rule, so the earnings portion of her withdrawal was taxable. She missed the deadline by less than 12 months. Fee-only fiduciary and CPA Wayne Firebaugh has spent more than 25 years watching this happen. The Roth IRA is one of the best retirement vehicles in the entire Internal Revenue Code, and also one of the most recommended and least explained products in the financial services industry. Almost nobody explains the rules that decide when that money is actually yours to take out tax-free. This episode opens a three-part mini-series, Roths Done Right. Part one is the mechanics, because every conversion decision in part two and every rollover decision in part three is built on top of these rules. Get them wrong and nothing else matters. The basic promise: you put in dollars that have already been taxed, and if you follow the rules, everything that comes out, decades of growth included, is tax-free. For 2026 you can contribute up to $7,500, or $8,600 if you're 50 or older. And since the One Big Beautiful Bill Act made today's tax brackets permanent, the old "convert before rates go up" urgency is gone. The question now is whether you have the mechanics right at all. The five rules nobody explains: 1. There isn't one five-year rule. There are two. If you remember nothing else, remember this: they start on different dates, measure different things, and carry different penalties. Clock one, the qualified distribution clock, is the one Janet missed. Before any earnings (growth, dividends, capital gains) can come out tax-free, you need two things: five tax years since your first Roth contribution, and a qualifying event, usually age 59½ (or death, disability, or a first-time home purchase up to a $10,000 lifetime limit). The clock starts January 1 of the tax year for which you made your first contribution to any Roth IRA. Contribute in April 2022 for tax year 2021, and the IRS treats your clock as starting January 1, 2021. It's one clock for every Roth IRA you'll ever own; a new account years later doesn't restart it. Your original contributions, meanwhile, always come out tax-free and penalty-free, at any age. Clock two, the conversion clock, is the one almost nobody knows exists. Every Roth conversion starts its own separate five-year clock, so three years of conversions means three clocks running. Pull converted principal out before its clock runs while you're under 59½ and you owe a 10% early withdrawal penalty on it. The classic trap: convert at 56, withdraw at 58, figure you already paid the tax. You did pay the tax. You still owe the penalty. Once you're past 59½, clock two essentially stops mattering. The line to write down: clock one governs whether earnings are tax-free, at any age. Clock two governs the 10% penalty on converted principal, and only if you're under 59½. 2. The ordering rules: the IRS picks which dollars come out first. You don't get to say "I'm only taking my contributions." The order is mandatory and layered by source. Layer one: every dollar you contributed directly, which comes out tax-free and penalty-free, always. Layer two: conversions, oldest first, which come out tax-free but can carry the 10% penalty if a conversion is under five years old and you're under 59½. Layer three: earnings, which come out last and are the only layer that can be hit with both income tax and the penalty. That's exactly what happened to Janet. About $20,000 of contributions, about $25,000 of earnings on top. Her $35,000 withdrawal took the $20,000 of contributions first, tax-free, then $15,000 of earnings that weren't yet qualified, taxed at her ordinary rate. Eleven more months and the whole thing would have been tax-free. And the ordering rules apply across all your Roth IRAs combined. Open as many accounts as you like; the IRS stops counting at one. 3. The pro-rata rule: where the backdoor Roth lives and dies. If your income is too high to contribute directly, the backdoor Roth lets you make a non-deductible $7,500 traditional IRA contribution and then convert it. With no other IRA money, the conversion is a tax wash. But the IRS aggregates every traditional, SEP, and SIMPLE IRA you own into one big pot, and every conversion comes out proportionally pre-tax and after-tax. Planners call it cream in the coffee: once it's poured, every sip is part cream, and you can't drink just the cream. Say you also have $100,000 of pre-tax money in a rollover IRA. Your total is $107,500, of which $7,500 is after-tax, so only about 7% of your conversion is tax-free basis. The other 93%, roughly $7,000, is taxable. In the 24% bracket, that's about $1,680 in surprise federal tax, plus state. The dangerous part: the calculation uses your balances on December 31 of the conversion year. Convert in March, roll an old 401(k) into an IRA in November, and the November balance retroactively contaminates the March conversion. The usual fix is rolling pre-tax IRA money into an employer 401(k) that accepts rollovers, since 401(k) balances aren't aggregated, but it has to happen before year-end, not next March when you discover the mess at tax time. Your after-tax basis is tracked on Form 8606, which should be filed every year you make a non-deductible contribution, including the first leg of every backdoor Roth. Skip it, and the IRS can treat all of your IRA money as pre-tax, so you pay tax twice on the same dollars. Missed forms can usually be filed retroactively. 4. IRMAA: the Medicare surcharge that arrives two years late. If you're 63 or older, this one's for you. Medicare Part B and Part D premiums are means-tested. The Income-Related Monthly Adjustment Amount adds a surcharge on top of the standard 2026 Part B premium of $202.90 a month, in tiers, using your modified adjusted gross income from two years earlier. A conversion done at 63 can raise your Medicare premiums at 65. For 2026, the first tier starts at $109,000 for single filers and $218,000 for joint filers. And IRMAA is a cliff, not a slope: one dollar over a threshold and you pay that tier's full surcharge. If both spouses are on Medicare, both pay. IRMAA isn't a reason to never convert, but it's a reason to size the conversion. If converting $60,000 keeps you under the next tier and $65,000 crosses it, that extra $5,000 can cost multiples of itself. An advisor who recommends a conversion without modeling the IRMAA effect is waving a big yellow flag. 5. There's no do-over anymore. Before 2018, you could recharacterize a conversion: if the market dropped or the tax bill turned out to be unaffordable, you undid it as if it never happened. The Tax Cuts and Jobs Act eliminated recharacterization of conversions starting in 2018, and the 2025 law made that framework permanent. Today a conversion is irrevocable. The nuance even many tax professionals miss: you can still recharacterize a contribution. Contribute to a Roth in January, discover in October your income was too high, and you can recharacterize it as a traditional IRA contribution before the filing deadline. So every conversion has to be sized right on the first try, with the tax, bracket, IRMAA, and estimated-payment impact modeled before you execute. There is no mulligan. The bottom line: two clocks, ordering rules you can't control, a pro-rata rule that can wreck a backdoor Roth, a surcharge that bills you two years later, and no undo button. Know them, and you're ahead of most Roth owners in the country. Free download, the Roths Done Right toolkit: the Roth Owner's Roadmap, a one-page flowchart that answers "Can I take this money out without tax or penalty?" from four inputs; the Two-Clock Worksheet, with a date field for clock one and a table for every conversion and its clock-two expiration date; and the Roth Glossary, about 30 terms in plain English, flagging where industry vocabulary misleads. Next time, Roths Done Right part two: from mechanics to math. When a Roth conversion actually pencils out, when it doesn't, and how to spot conversion advice that's really about the person getting paid on your converted balance. If you'd like a second set of fiduciary eyes on your Roth setup (whether it's sized right, whether you should be converting, whether you're unknowingly running afoul of the pro-rata rule), book a no-pressure, educational conversation at fireproofyourmoney.com. Wayne Firebaugh Inc. is a fee-only firm registered as an investment advisor in Virginia and does not sell commissioned products. Everything in this episode is general education, not personalized investment, tax, or legal advice. Your situation is your own, so please see a professional before you act. Get the mechanics right before you make a move you can't undo. Choose wisely.