Roth IRAs are one type of account that can help you reach your financial goals. However, there can be pitfalls if you don’t know all the rules.
Read on to learn more.
Michelle Morris, CFP®, EA
BRIO Financial Planning
- ROTH IRAs are 20 years old next year! They are named after Senator William Roth of Delaware, their chief legislative sponsor.
- A ROTH IRA is an investment vehicle focused on retirement savings. It is funded with after-tax dollars. This means you do not get an up-front tax deduction.
You can contribute $5,500/year to a ROTH IRA; $6,500 if you are 50 or older. (One of the benefits of aging!)
Fun Fact:When ROTHs started in 1998 the contribution limit was just $2000/year!
- To contribute, you (or your spouse if filing your taxes jointly) must have “earned income”. Earned income includes wages, salaries, commissions, tips, or net income from self-employment. Taxable alimony is considered earned income for IRA contribution purposes.
- There is no age limit for contributing to a ROTH. You can contribute at any age as long as you have earned income. This differs from a Traditional IRA which does not allow contributions starting the year you turn 70½.
- Your contributions (the money you contribute) can be withdrawn from your ROTH any time for any reason, tax and penalty free. You could put $1,000 into your ROTH IRA this week, decide next week to take it out to buy some magic beans. This is allowed, no penalty, no tax. I do not recommend it however! For this reason it is important to keep track of your ROTH contributions.
- Qualified distributions of the earnings from the ROTH IRA are tax free if they are “qualified”. A distribution is qualified when you’ve had a ROTH for 5 years AND you are at least 59½ years old. Or if you’re disabled, have died (the distributions to your beneficiaries are qualified) or are using up to $10,000 for a first time home purchase.
- There are income limits to making a ROTH IRA contribution. In 2017 if your Modified Adjusted Gross Income (MAGI) is over $118,000 as a single tax filer, or over $186,000 for a married filer, your ROTH IRA contribution is limited. At $133,000 and $196,000 of MAGI for singles and married respectively, no contribution is allowed.
- The deadline for contributing to a ROTH IRA is generally April 15th of the following year. For 2016 contributions the deadline is 4/18/17. For 2017 contributions the deadline is 4/17/2018. For those close to the income limit, it can make sense to wait until after year end so you know for sure what your contribution limit is.
- There are no RMD’s (Required Minimum Distributions) from a ROTH IRA. If you inherit a ROTH IRA however, you do have to take RMDs from the inherited ROTH.
- You can set up a ROTH IRA at any brokerage. I like Vanguard for their low-cost index funds.
- Check your beneficiaries! When you die your ROTH IRA will go to whoever you named as a beneficiary. It does not matter what your will says. Make sure it’s not your lousy ex-spouse!
Which is better, Roth or Traditional IRA? Good question! Queen Ira-Bella (that’s me!) can tell you all about that here.