American workers saving for retirement are generally aware that there are key considerations around 401(k) accounts and Roth IRAs, but bestselling personal finance author Dave Ramsey strongly urges his readers to learn about the five-year rule. Charles Schwab (particularly on IRAs) and the IRS add clarifying details.

You can begin taking penalty-free withdrawals from either a traditional or Roth 401(k) once you reach age 59½. However, to access your Roth earnings tax-free, your account must also meet the five-year aging requirement, according to the Internal Revenue Service (IRS).

“Now, if you’re still decades away from retirement, that five years is nothing to worry about,” Ramsey wrote. “But if you’re approaching 59 1/2 and thinking about opening a Roth 401(k), be aware that if you make withdrawals within those first five years, you’ll pay a penalty.”

On another important note, when it comes to accessing your money, a main distinction between these two plans is the Required Minimum Distribution (RMD) rule.

Required minimum distributions are the minimum amounts you must withdraw from your retirement accounts each year, explains the IRS.

“If you have a traditional 401(k), the IRS requires you to start making withdrawals from your account beginning at age 73 (they want that tax money, baby),” Ramsey wrote.

“Thanks to the SECURE 2.0 Act, Roth 401(k)s no longer have RMDs,” he continued. “If you’re the original account owner, you can leave your Roth 401(k) untouched for as long as you want.”

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Charles Schwab explains ways to avoid 5-year rule penalties on Roth IRAs

Withdrawing earnings from a Roth IRA before age 59½ and before your account hits the five-year mark, generally incurs income taxes and early-withdrawal penalties. However, you can bypass the penalties, according to financial services firm Charles Schwab.

There are several situations that avoid the penalties.

Eligible penalty exemptions fall into three primary categories: qualifying life events, physical or financial hardships, and specific legal or administrative circumstances, Schwab explains.

You can bypass the early withdrawal penalty if the funds support major milestones — such as purchasing a first home (up to a $10,000 lifetime maximum), paying higher education tuition, covering birth or adoption costs, or handling urgent emergency needs.

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Relief is also available during significant health or economic setbacks, including paying unreimbursed medical bills, maintaining health insurance while unemployed, suffering a total disability, or disbursing funds following the account holder’s death.

Finally, the IRS waives the penalty for special circumstances, such as distributions for domestic abuse survivors, federally declared disaster relief, forced IRS levies, or structured schedules taken as substantially equal periodic payments.

“If you’ve met the five-year holding requirement, you can withdraw money from a Roth IRA with no taxes or penalties,” Schwab clarified.

“Remember that, unlike a Traditional IRA, with a Roth IRA there are no required minimum distributions.”

Both Dave Ramsey and the IRS warn that failing to meet the mandatory 5-year holding rule can compromise your 401(k) withdrawals.

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Dave Ramsey recommends Roth 401(k) plans

“If you’re investing consistently every month, whether it’s in a traditional or Roth 401(k) (or even a Roth IRA), you’re already on the right track,” Ramsey wrote. “But if you’re looking for the best retirement savings option, there are two big reasons the Roth 401(k) comes out on top.”

The first is that there are no taxes on growth or withdrawals.

“The tax-free growth and tax-free withdrawals that come with a Roth 401(k) are simply too good to pass up,” Ramsey wrote. “Anytime you can legally minimize your tax burden, that decision makes itself.”

“It may be tempting to take the tax break now so you can take home a little more in your paycheck today,” he added. “But you’ve got to think about these things with a long-term mindset. You’re already working hard to save for retirement. Why wouldn’t you do all you can to make sure that money goes even further when you need it most?”

The second reason to invest in a Roth 401(k), Ramsey explains, is peace of mind.

“Like it or not, it’s hard to separate emotions from investing,” Ramsey wrote. “Imagine finally stepping into retirement, then watching your $1 million nest egg get whittled down by hundreds of thousands of dollars because of taxes. We bet you’d miss $100,000 in retirement a lot more than $100 in a paycheck today.”

“Besides, once you’re in the habit of investing 15% of every paycheck for retirement, you probably won’t even miss the money you’re paying in taxes,” he said. “Plus, you’ll have peace of mind from knowing the tax bill has already been handled.”

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