If you don’t have a Roth IRA, you probably should. Roth’s are great planning tools. They can be used to save for retirement, save for college (bet you didn’t know that one) and convert traditional IRA assets in a process known as backdoor Roth.
What is a Roth IRA?
I’m sure most of you have heard of Roth IRA’s and are at least somewhat familiar with the benefits of such an account. Here’s a brief overview: a Roth IRA is a retirement account funded with after-tax income and if the rules of a Roth account are followed, and the account is qualified, the earnings generated from the account can be withdrawn income tax free when it comes time for distribution. Thus, the longer the money is compounding in the Roth, the more advantageous it becomes.
Roth IRA vs. Traditional IRA
If you were a farmer, would you rather take some short-term pain and pay taxes on the seeds you buy, knowing that your harvest would be tax-free? I hope most of us would take the short-term pain to reap the larger reward (less total taxes) when it comes time to harvest. This is one of the best analogies I’ve heard for a comparison between a Roth IRA and a Traditional IRA. Now it’s not completely apples-to-apples because you must consider tax rates and timing when deciding between a Roth or traditional IRA but it’s mostly accurate.
Roth IRA Rules
And of course, any account that comes with certain advantages, also comes with certain rules.
$6,000 limit, plus $1,000 catch up if over 50 ($7,000 total)
These contributions are phased out for taxpayers with modified adjusted gross income (MAGI) of:
- $122,000-137,000 for single taxpayers
- $194,000-203,000 for married filing jointly
Required Minimum Distributions (RMD’s) do not apply with Roth IRA’s so you can contribute past the age of 70.5
Roth IRA Distribution Rules for 2019
Since contributions are after-tax, they will not be taxed again and can be withdrawn tax and penalty free regardless of when they are contributed.
For all account contribution money to be qualified, the account must be open at least 5 years and one of the following:
- Owner age is 59 ½
- Owner dies
- Owner becomes disabled
- Payment is made on a first-time home with a $10,000 lifetime cap
* It is not possible for a Roth to be qualified if the five-year holding period is not met
* If you are over 59 ½ and have not met the five-year holding requirement, your earnings (not contributions) will be subject to taxes but not penalties.
Roth conversions, as opposed to contributions, are treated a bit different. As shown above, contributing directly to a Roth IRA is restricted if your income is beyond certain limits, but currently, there are no income limits for conversions.
My next post will cover the underutilized tool of Roth conversions and how they can add real value and how a Roth account can also be used as a type of college savings account.
*Always consult your tax advisor of financial planner before you decide to make any changes!