A Roth IRA is a great tax planning tool to include in your retirement plan. Roth IRAs can be used to save for retirement, save for college (bet you didn’t know that one!), and convert traditional IRA assets. In this article, I talk about the difference between traditional IRAs and Roth IRAs and explain the Roth IRA contribution limits and Roth IRA distribution rules.
What is a Roth IRA?
A Roth IRA is a retirement account funded with after-tax income. 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the rules of a Roth account are followed, and the account is qualified, the earnings generated from the account can be withdrawn income tax free when it comes time for distribution. (See Roth IRA Distribution Rules below for what it means to be "qualified.") Thus, the longer money is compounding in a Roth IRA 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 (lower total dollars paid in 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. It’s not completely apples to apples because you must consider tax rates and timing when deciding between a Roth IRA or a traditional IRA, but it’s mostly accurate.
|Rules||Roth IRA||Traditional IRA|
|2023 IRA Contribution Limits||$6,500 ($7,500 if age 50 or older) or the amount of your earned income, if lower||$6,500 ($7,500 if age 50 or older) or the amount of your earned income, if lower|
|2023 IRA Income Limits||Single filers with MAGIs under $153,000 (phase out begins at $138,000), married filing jointly with MAGIs under $228,000 (phase out begins at $218,000)||No income limits to contribute, but tax deductibility is subject to income limits and participation in an employer plan.|
|2023 IRA Tax Credit Available||Available for "saver's tax credit" of up to 50% for single filers with AGIs less than $33,000 and married filers with AGIs less than $66,000.||Available for "saver's tax credit" of up to 50% for single filers with AGIs less than $36,500 and married filers with AGIs less than $73,000.|
|IRA Tax Treatment||No tax deduction for contributions; tax-free earnings and withdrawals in retirement.||Tax deduction in contribution year; ordinary income taxes owed on withdrawals in retirement.|
|IRA Withdrawal Rules||Contributions can be withdrawn at any time, tax free and penalty free. Withdrawals of earnings are tax free and penalty free beginning at age 59½ as long as the account has been open at least 5 years.||Withdrawals are penalty free beginning at age 59½.|
|Required Minimum Distributions (RMDs)||No RMDs for the account owner. Account beneficiaries are subject to RMD rules.||Distributions must begin at age 73 for the account owner (age 75 for those born in 1960 and later). Account beneficiaries are also subject to RMD rules.|
Roth IRA Contribution Limits 2023
Of course, any account that comes with certain advantages also comes with certain rules.
Total contributions to traditional and Roth IRAs for 2023 can't be more than $6,500 ($7,500 if age 50 or older) or the amount of your earned income for the year, whichever is lower.
Roth IRA income limits: Roth contributions are phased out for taxpayers with modified adjusted gross incomes (MAGIs) of: $138,000-153,000 for single taxpayers and $218,000-228,000 for married filing jointly
- There is no age limit for contributing to a Roth IRA. You may contribute to a Roth IRA as long as you have earned income. The same is now also true for traditional IRAs starting in 2020 thanks to the SECURE Act.
Roth IRA Distribution Rules
- Since Roth IRA contributions are made after taxes, those contributions will not be taxed again. Your IRA Roth contributions can be withdrawn tax and penalty free regardless of when they are contributed.
- In order for Roth IRA earnings (amounts above contributions) to be qualified, the account must be open at least 5 years* and one of the following must apply:
- Owner's age is at least 59 ½
- Owner dies and the money is withdrawn by the beneficiaries or estate.
- Owner becomes disabled
- Money is used for a first-time home purchase with a $10,000 lifetime cap
- Required Minimum Distributions (RMDs) do not apply to Roth IRAs. Owners of traditional IRAs are required to take distributions at age 73 (age 75 if born in 1960 or later).
* It is not possible for a Roth to be qualified if the five-year holding period is not met. If you are over age 59 ½ and have not met the five-year holding requirement, your earnings (not contributions) will be subject to taxes but not penalties.
Are you ready to go deeper and learn more about how Roth IRAs can be used for tax planning to reduce your lifetime tax liability?
Read the next article in this series about Roth IRAs to learn how to convert money from a traditional IRA to a Roth IRA and why you might want to consider doing so. In that article, I also cover how you can use a Roth IRA for college savings. It's also a podcast episode if you'd prefer to listen.
Read the next article or listen to the podcast episode here: Reducing Taxes Using Roth IRA Conversions