Roth Withdrawals: How to Avoid the 5-Year Trap

Roth accounts are powerful tools for PG&E retirement, but only if you know the rules. One of the most misunderstood aspects of the Roth 401(k) and Roth IRA is how and when you can withdraw the money tax-free and penalty-free.

Here’s the plain-English guide to how Roth distributions really work, why the five-year rule matters, and how to avoid a costly mistake when you roll a Roth 401(k) into a Roth IRA.

The Goal: Tax-Free Income in Retirement

The appeal of a Roth account is simple: you pay the taxes up front, then never again.

Once you meet the rules, your earnings grow tax-free and your withdrawals stay tax-free.

That means no taxes on dividends, no taxes on growth, and no taxes on withdrawals during retirement, if you follow the steps.

But those “steps” include one rule that trips up even experienced investors: the five-year rule.

The Two Different 5-Year Rules

There isn’t just one five-year rule. There are two, and the rules apply differently depending on whether you’re talking about Roth IRA contributions or Roth conversions.

Let’s look at both.

Rule #1 – The 5-Year Rule for Earnings (Qualified Distributions)

This is the rule most people think of.

To take out your earnings tax-free, two conditions must be met:

1. You’ve had any Roth IRA open for at least five tax years, and
2. You’re at least 59½ years old, disabled, deceased, or using the funds for a first home (up to $10,000).

The five-year clock starts on January 1st of the year you first contribute to any Roth IRA.

So, if you opened your first Roth IRA with just $100 in December 2025, your five-year period starts January 1, 2025, and you’d meet the requirement on January 1, 2030.

That means even a small Roth opened today can “start the clock” and save you from problems later.

Rule #2 – The 5-Year Rule for Converted Funds (Penalty Avoidance)

Conversions have their own five-year clock, separate from the one above.

If you convert money from a traditional 401(k) or IRA into a Roth, that converted amount is always tax-free (you already paid taxes when you converted).

But if you withdraw it before age 59½ and within five years of the conversion, the IRS can slap you with a 10% early withdrawal penalty.

Each conversion starts its own five-year clock.

If you do annual conversions, you could have several overlapping five-year windows.

Once you’re over 59½, this penalty clock no longer matters; your converted funds can be withdrawn penalty-free at any time.

The Roth Ordering Rules: What Comes Out First

When you take money from a Roth IRA, the IRS has an exact order for what comes out first:

1. Contributions (Money from your paycheck or from a bank account) – always come out first and are tax and penalty-free.
2. Conversions (Money that was in another tax-deferred account you convert to a Roth account) – come out next, on a first-in, first-out basis.
3. If the conversion is less than 5 years old and you’re under 59½, → 10% penalty applies.‍
4. Earnings (Growth on the money in your Roth account)– come out last and are tax-free only if you meet the qualified distribution rules.

All your Roth IRAs are treated as one combined account for these rules. So, it doesn’t matter which Roth you take money from; the IRS looks at them all together.

This system is sometimes referred to as the “aggregation rule.” It’s designed to make sure you don’t game the system by keeping different Roths for different purposes

The Hidden Pitfall: Rolling a Roth 401(k) into a Roth IRA

Here’s where even smart people get tripped up.

When you leave a job or retire, you may roll your Roth 401(k) into a Roth IRA.

That’s common, and usually smart, but it can reset your five-year clock if you’re not careful.

Why?

Because Roth 401(k)s and Roth IRAs follow separate five-year clocks.

• The clock for a Roth 401(k) starts when you make your first contribution to that plan.
• The clock for a Roth IRA begins when you make your first Roth IRA contribution (not conversion).

So, if you start a Roth 401(k) with PG&E benefits in 2026 but never open a Roth IRA, and you roll it over when you retire, your new Roth IRA clock starts fresh.

That means for the next five years, your earnings might not be qualified distributions. You may owe tax on growth if you withdraw too soon.

The Simple Fix: Open a Roth IRA Today

There’s an easy way to avoid that problem: open a Roth IRA now, even with a small contribution.

By starting your five-year clock early, you eliminate the risk of the “reset” when you eventually roll your Roth 401(k) into an IRA.

You don’t have to fund it heavily. Even $50 or $100 is enough to get started.

Then, no matter when you retire or convert, your Roth IRA will already meet the five-year requirement for qualified withdrawals.

Think of it like planting a tree.

The best time was five years ago. The second-best time is today.

How to Keep It Straight

Here’s a simple summary:

Why the Rules Exist

The IRS established these rules to prevent individuals from utilizing Roth conversions or rollovers as short-term tax shelters.

If there were no waiting period, someone could convert a big IRA, withdraw the money the next day, and skip all taxes.

The five-year rule keeps Roth accounts focused on retirement, not short-term tax timing.

But once you understand the clocks and how they work together, you can plan your distributions confidently and keep your income tax-free for life.

Practical Planning Tips for PG&E Employees

1. Open a Roth IRA now – even if you’re focused on your PG&E Roth 401(k). It starts your long-term clock. We can help!
2. Track your conversions – keep a simple list with the year, amount, and whether it’s cleared its five-year window.
3. Don’t rush to roll over – if your Roth 401(k) is older than your Roth IRA, it might be better to leave it in the plan a little longer to avoid resetting your clock.
4. Coordinate before distributions – timing matters. Talk with a tax professional before tapping Roth funds, especially if you’re under 60.
5. Plan withdrawals strategically – remember, your contributions are always withdrawn tax-free first. Use those first if you need short-term access.

Summary

The Roth is one of the most valuable tools in retirement planning, but only if used correctly.

By understanding which money comes out first, how the five-year rules work, and how to avoid resetting your clock during a rollover, you can protect decades of tax-free growth.

At Powering Your Retirement, I help PG&E employees make smart, coordinated decisions about Roth contributions, conversions, and distributions, so their plan isn’t just tax-smart, it’s life-smart.

If you haven’t opened a Roth IRA yet, start small and start today.

Your future self will thank you.