Blog: The Ultimate Roth IRA Guide

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Are you trying to decide which retirement savings plan is best for you? A Roth IRA is a retirement savings vehicle that can allow your contributions to grow tax-free. There are several benefits to a Roth IRA. It is most beneficial for those who are currently in a relatively low or mid tax bracket, and will likely be in a higher tax bracket later in life.

There is no age limit to open a Roth IRA, but it is very beneficial the younger you start. Through leveraging the power of compound interest, you can potentially reap a steady stream of tax-free income during retirement! In this blog, we will explore the Roth IRA in greater detail so you can decide for yourself if it’s the right retirement savings plan for you.

What is a Roth IRA?

A Roth IRA is an individual retirement account (IRA) in which money grows tax-free. It was established in 1997. The contributions are not tax-deductible but all future withdrawals are tax-free. There are currently no required minimum distributions, provided the account holder is alive and has not passed on the Roth IRA to a beneficiary after his/her death.

Who qualifies for a Roth IRA?

Anyone can qualify and open a Roth IRA as long as they meet certain income thresholds and have reported income to the Internal Revenue Service. For example, some teenagers with part-time jobs could open a Roth IRA but a teenager who is getting cash for cleaning backyards cannot. A 75-year old lawyer who is working part-time can still be eligible for a Roth. There is no age limit to open a Roth IRA.

If you are a non-working spouse or a spouse with low wages, then you may also qualify for a spousal Roth IRA. A Roth IRA is generally best if you think your taxes will be higher in retirement than what they are now.

How much can you contribute to a Roth IRA in 2022?

The Roth IRA contribution limit for 2022 is $6,000. This is unchanged from 2021. If you are 50 and older then you can contribute $7,000. The contributions for a tax year must be made by the IRA owner’s tax filing date. This date is generally April 15 the following year. For example, to contribute towards tax year 2021, one has until April 18th, 2022 this year to do so.

You must have earned income to be eligible for a Roth IRA. This includes salaries, bonuses, commissions, consulting gigs, and small business income. It is generally any amount that is shown in Box 1 on the individual’s Form W-2 or on a 1099.

What are the Roth IRA income limits for 2022?

You can’t contribute to a Roth IRA if you make too much money. The income limit has increased for 2022 so that means that more Americans can now contribute to a Roth IRA.

What are the benefits of a Roth IRA?

  • Tax-free income in retirement: Since you pay the taxes up-front, you can make tax-free withdrawals during retirement. This is a major advantage. If you decide to take one large lump sum, then you don’t have to worry about being bumped up to a higher tax bracket.
  • Easy withdrawals: you can withdraw the money that you contributed at any time without any penalties or taxes.
  • Tax-free and penalty-free withdrawal for first-home buyers: You can withdraw up to $10,000 of earnings from your Roth IRA without paying income tax or the early withdrawal penalty if you use the money for the purchase of your first home.
  • You can contribute to a Roth IRA as well as a Roth 401(k): If your income allows, then you can contribute to both.
  • Flexible timing: You can choose to contribute to your Roth IRA whenever it suits you. If you are ahead in your savings, you could contribute the full $6,000 on the first day of the year.
  • Tax-free distributions: once you hit 59 ½ and have been contributing to a Roth IRA for at least 5 years, then you can make tax-free withdrawals of your earnings.
  • No required minimum distributions: Roth IRAs are exempt from RMDs. This means that you can leave the money in your Roth to pass on to heirs or a charity if you choose.
  • Contributions are allowed at any age: You can continue to contribute to a Roth IRA for as long as you like (as long as you meet income eligibility requirements)

What are the disadvantages of a Roth IRA?

The major disadvantage of a Roth IRA is that they do not include an up-front tax break. This is also the major difference between a Roth IRA and a pre-tax 401(k). There is also no automatic payroll deduction so you need to make sure that you remember to contribute each year.

Spousal Roth IRA

A non-working spouse can contribute to a Roth IRA, as long as their household income meets the eligibility limit. These contributions are subject to the same rules and limits as regular Roth IRA contributions. This Roth IRA account will be separate from the working spouse’s Roth IRA account as Roth IRAs cannot be joint.

Roth IRA Withdrawal Rules

There are Roth IRA withdrawal rules that you must follow. You can withdraw your Roth IRA contributions at any time without owing any penalties or taxes. Qualified withdrawals of earnings can be tax-free and penalty-free but it does complicate things with the IRS. Be careful doing this because you can be taxed if those withdrawals do not meet the ‘qualified’ definition.

People who have had their Roth IRAs for at least 5 years and are at least 59½ years old can withdraw contributions and earnings without paying federal taxes.

Withdrawals that are not ‘qualified’ will be subject to income tax and/or a 10% early distribution penalty. There are some exceptions which include childbirth/adoption expenses, qualified higher education expenses and medical insurance.

Opening a Roth IRA

A Roth IRA can be established with any institution that has approval from the IRS to offer a Roth IRA. This includes banks, brokerage firms, credit unions and loan associations.

There are two documents that need to be read/signed by the IRA owner to establish a Roth IRA. These include:

  1. The IRA disclosure statement
  2. The IRA adoption agreement and plan document

Backdoor Roth IRA

If your income is too high and you are ineligible to open a Roth IRA, you may still be able to contribute via a backdoor Roth IRA. A backdoor Roth IRA involves putting money into a traditional IRA, and then converting that account to a Roth IRA. In any year, you can convert as much of your traditional IRA to a Roth IRA as you want, as long as you pay the taxes on the earnings. There are several steps that need to be done to execute a backdoor Roth properly. If you want to learn how to do a Backdoor Roth IRA, check out our blog.

Who can help me make decisions about my Roth IRA?

Roth IRA is a great retirement savings plan for you to consider since there are no required minimum distributions and you withdraw the money tax-free. A financial planner can help you decide if it is the right choice for you. Whether you want to open a Roth IRA, max it out, or if you are changing jobs or a combination of all of these, we are here to help guide you.

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