The IRA that changed the retirement savings landscape
You can sum up the appeal of a Roth IRA in three words: federal tax benefit. Since the Roth IRA was introduced in 1998, its popularity has soared. It has become a fixture in many retirement planning strategies because it offers savers so many potential advantages. The big attraction is the potential for tax-free retirement income, not to mention tax-exempt growth for the account. Here are some of the potential benefits associated with opening and contributing to a Roth IRA:
1) What you see is what you get.
Roth IRA contributions are made with after-tax dollars, and any potential earnings on investments within a Roth IRA are not subject to income tax or included in the account owner’s income. Instead, they accumulate on a tax-deferred basis and are tax-free when withdrawn from the Roth if the distribution is qualified.1
2) You can arrange tax-free retirement income.
Roth IRA earnings can be withdrawn tax-free as long as you are 59½ or older and have owned the account for at least 5 years. The IRS calls such tax-free withdrawals qualified distributions.
3) Withdrawals don’t affect taxation of Social Security benefits.
If your provisional income is between $25,000 and $34,000 — or $32,000 and $44,000 for joint filers — then your Social Security benefits may be taxed if you take withdrawals before your full retirement age. Luckily, a qualified distribution from a Roth IRA doesn’t count as taxable income, which may be a means of avoiding taxation on your social security benefit.3,4
4) No mandatory withdrawals.
While mandatory annual withdrawals are required from traditional IRAs starting at age 72, no mandatory annual withdrawals are required from Roth IRAs while the original owner lives. Under the 2019 SECURE Act, most non-spouse beneficiaries of a Roth IRA are required to have the funds distributed to them by the end of the 10th calendar year following the year of the original owner’s death.
5) You have until your tax-filing deadline to make a Roth IRA contribution for a given tax year.
For example, IRA contributions for the 2019 tax year may be made up until the July 15, 2020 tax-filing deadline.
6) High-income taxpayers may create Roth IRAs indirectly.
Remember, though that Roth IRA contributions cannot be made by taxpayers with high incomes. In 2020, joint filers with modified adjusted gross incomes (MAGI) of $206,000 or more and single filers with MAGI of $139,000 are not eligible for a ROTH IRA.
However, there is a way for high earners to bypass these limits: the “backdoor” Roth IRA strategy.6 This typically starts with the creation of a traditional IRA. The contributions to this new IRA are usually non-deductible, because of the IRA owner’s high modified adjusted gross income. This new traditional IRA is fully or partly funded, then quickly converted to a Roth IRA, and any tax liability is paid.7
Note: Speed matters. The longer it takes to convert the traditional IRA into a Roth IRA, the greater the potential earnings of that traditional IRA. Since any traditional IRA earnings converted over to the Roth represent taxable income, those earnings should be minimal if the transfer is completed shortly after making the contribution.
How much can you contribute to a Roth IRA annually? The combined annual contribution limit to all of your traditional and Roth IRAs is $6,000 for 2019 and 2020 ($7,000 if you’re age 50 or older), but income limits may reduce or eliminate your ability to contribute. To sweeten the deal even further, you can keep making annual Roth IRA contributions all your life.8
Who can open a Roth IRA? Anyone with earned income (and that includes a minor).
Note: The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
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This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate.
- 1,2 – irs.gov/retirement-plans/traditional-and-roth-iras [1/28/20]
- 3 – kiplinger.com/slideshow/retirement/T055-S001-how-retirement-income-is-taxed/index.html [1/27/20]
- 4 – irs.gov/retirement-plans/traditional-and-roth-iras [1/28/20]
- 5,6 – IRS.gov February 24, 2020
- 7 – RetirementPlans.Vanguard.com May 11, 2020
- 8 – irs.gov/retirement-plans/traditional-and-roth-iras [1/28/20]