A Roth IRA account is similar to a traditional IRA, except contributions to a Roth IRA are made with after-tax dollars, whereas contributions to a traditional IRA are made with pre-tax dollars. Contributions to a traditional IRA are tax-deductible but contributions to a Roth IRA are not tax-deductible, so why choose a Roth IRA?
A Roth IRA has advantages unlike most other qualified retirement plans. For example, a Roth IRA account is not subject to mandatory minimum distributions above a certain age, unlike a 401(k) or traditional IRA.
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Why Choose A Roth IRA?
Roth IRA contributions are made with after-tax dollars that grow tax-free, and may be withdrawn in retirement years without paying any income tax.
Contributions to a Roth IRA are made with after-tax dollars so no initial tax benefit is enjoyed, unlike with a traditional IRA. As time goes by, a Roth IRA makes more economic sense because portfolio growth is tax-free. When you begin taking withdrawals in your retirement years, you do not pay any income tax on the principal contributed or earnings generated.
This means that the tax rate you pay today is locked in, which can be a good thing. If you expect your income and hence tax rate to increase in the future, or if you expect taxes to rise over time, contributing to a Roth IRA account makes sense; you lock in a lower rate today than you would otherwise have to pay in the future.
How Much Can I Contribute To My Roth IRA?
The maximum amount you can contribute to your Roth IRA depends on your age and how much you earn. Because Roth IRA accounts are tax-advantaged, restrictions are imposed on high-income earners but individuals over the age of 50 are allowed to contribute an additional $1,000 more than those under the age of 50. And married couples both over the age of 50 who meet Roth IRA income limit thresholds are permitted to contribute an additional $2,000 annually.
Individuals under the age of 50 are permitted to contribute a maximum of $5,500 annually to a Roth IRA. Over the age of 50, a maximum $6,500 can be contributed per person.
Married couples under the age of 50 can contribute $11,000 annually while couples with both partners over the age of 50 are allowed to contribute a slightly higher annual amount of $13,000.
Because the Roth IRA is a tax-advantaged account with unique benefits, restrictions are imposed on high income earners, based on Roth IRA rules and limits. For individuals with adjusted gross income above $118,000, the permitted contribution is lower than the maximum. For married couples, the adjusted gross income threshold is $186,000, at which stage permitted contributions are lower than the maximum amount.
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When Can I Take Roth IRA Distributions?
Distributions of a Roth IRA can be taken above the age of 59.5 years old.
Individuals over the age of 59.5 years who have held the account for five years are permitted to take distributions from their Roth IRA account. Because contributions to the Roth IRA were made with after-tax dollars, all distributions including earnings can be taken without paying federal taxes.
Other times when Roth IRA distributions may be taken and deemed qualified include:
- When building a first home for the Roth IRA account holder or a qualified family member, such as the Roth IRA account holder’s spouse, child or grandchild. A limit of $10,000 per lifetime is imposed.
- When the Roth IRA account holder becomes disabled.
- When the Roth IRA account holder dies, the assets may be distributed to the beneficiary of the Roth IRA account holder.
What Is The Penalty For Withdrawing Roth IRA Funds Early?
A 10% early distribution penalty in addition to income taxes is applied unless it qualifies as an exception, such as paying for qualified higher education expenses, unreimbursed medical expenses or medical insurance after losing a job.
A non-qualified Roth IRA distribution is made when it doesn’t meet the eligibility rules above, and may be subject to a 10% early-distribution penalty in addition to income taxes owed.
Certain exceptions are permitted, including paying for:
- Medical insurance when the individual has lost a job.
- Qualified higher-education expenses of the Roth IRA account holder or dependents. Tuition, fees and books qualify as eligible expenses.
- Unreimbursed medical expenses: the medical expense minus 10% of the adjusted gross income for the year of the distribution may be distributed penalty-free.
How Do I Start A Roth IRA Account?
A Roth IRA account can be opened at a qualified financial institution, such as an online brokerage firm and contributions for a tax-year must be made by April 15 of the following year.
You can establish a Roth IRA account at any time but contributions for a tax year must be made by April 15 of the subsequent year, and no tax filing extensions are permitted.
To get started, simply select a financial institution qualified to handle Roth IRA, such as savings and loan associations, federally insured credit unions, banks and online brokerage firms.
Before opening an account, it is best to research providers, such as online trading platforms, to assess investment options, such as:
- Low-cost investment funds, such as exchange-traded funds;
- Ongoing fees, such as inactivity fees; and
- Transaction costs, especially for active day traders.
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Can I Rollover a 401(k) Into A Roth IRA?
You can rollover a 401(k) into either a Roth IRA or a traditional IRA, but if you roll it over into a Roth IRA, you will be obligated to pay taxes on the amount contributed.
You are permitted to rollover a 401(k) account into a Roth IRA but because contributions to a 401(k) are made with pre-tax dollars while the Roth IRA contributions are made with after-tax dollars, you will need to pay taxes on the amount rolled over into your Roth IRA. No taxes are paid when rolling over a 401(k) into a traditional IRA account.
Is My Roth IRA Insured?
The Federal Deposit Insurance Corporation offers insurance protection of $250,000 on Roth IRA accounts.