5 Roth IRA Rules You Need to Know

A Roth IRA can be your most powerful tool in saving for retirement. But to take advantage of this amazing wealth-building strategy, you need to be familiar with all the Roth IRA rules that define whether you can use it and how to make the most of it. Let's take a look at the five most important Roth IRA rules to keep in mind.

Rule 1: Too much income means no Roth for you.
The first rule to keep in mind is that some people aren't allowed to contribute to a Roth. For 2013, single filers with more than $127,000 in what's known as modified adjusted gross income can't make any contribution to a Roth, while those with incomes between $112,000 and $127,000 are stuck with reduced contributions. For joint filers, the similar limits are $178,000 and $188,000.

Rule 2: The amount you can contribute just went up.
Roth contribution limits are indexed for inflation, and in 2013, they went up. Now, you can put $5,500 into your Roth IRA, and if you're 50 or older, you can add another $1,000 on top of that. If you haven't made a contribution for 2012 yet, you still have until April 15 to do so -- the limits for last year are $5,000 and $6,000, respectively.

Rule 3: Anyone can convert a traditional IRA to a Roth.
It used to be that income limits prevented some taxpayers from converting existing traditional IRAs to Roth IRAs. But in 2010, those rules went away, and now, anyone can convert. Just keep in mind that converting to a Roth usually creates immediate tax liability, as you have to include the amount converted in your taxable income for the year of the conversion. Given the tax-free benefits of Roth IRAs, paying extra tax now might be worth it, but you still have to run the numbers.

Rule 4: Be careful when you take distributions from your Roth IRA.
If you do everything right, money you take from your Roth will always be tax-free. But complicated rules govern withdrawals from Roth IRAs, and if you're not careful, you can turn tax-free income into taxable income or even have to pay penalties. In general, you can withdraw your initial contributions at any time without penalties or tax consequences, but if you take out earnings within the first five years you have the account or before you turn 59 1/2, you'll owe a 10% penalty unless it qualifies for exceptions such as disability, first-time home costs, or higher-education expenses.

Rule 5: Be smart about beneficiaries.
If you plan to use up your Roth IRA assets before you die, then worrying about beneficiaries may seem silly. But Roth accounts can be great estate planning tools because they allow your heirs to take advantage of their tax-free benefits as well. So in choosing a Roth beneficiary, be sure to take into account the fact that your chosen heirs will be allowed to draw down the Roth gradually over their remaining life expectancy. The younger the beneficiary, the longer those assets will grow tax-free.

Use your Roth the right way
Roths are great tools, but knowing these Roth IRA rules is important to ensure you don't make mistakes that could jeopardize your retirement savings. For more on Roths, be sure to take a look at the IRS website, which includes a lot of useful information on both traditional and Roth IRAs.

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  • Report this Comment On April 05, 2013, at 1:47 PM, TMFJebbo wrote:

    As I understand it, high income earners cannot DIRECTLY contribute to a Roth. But they can contribute to a Traditional IRA and then roll it into a Roth. So for Rule 1 & 3, I just put post-tax money into a Traditional account, and then immediately roll it into a Roth. Effectively nullifying

    Rule 1. (I have been told by my accountant and the IRA people that this is OK.)

  • Report this Comment On April 05, 2013, at 6:52 PM, MMILVO wrote:

    Actually the only article I have ever read that recognized you can take out for college costs. Good job. Cannot believe more dont use as their college savings accounts. You keep control. Use for dependents costs. Keep the rest for retirement. Best use ever.

  • Report this Comment On April 08, 2013, at 12:05 PM, notsosmot wrote:

    I don't understand these financial matters too well. I have trouble understanding the benefit of an IRA. If one pays 30% taxes up front or out back, mathematically it still works out the same. In my case, after retirement and when I start churning my investment portfolio, my income will be higher than when I was working.

    Actually, I can see that dividends should be tax-free, if one invests in that sort of stock. But I don't, mostly. What am I missing?

  • Report this Comment On April 08, 2013, at 1:49 PM, foolingtoday wrote:

    OK notso, I'll bite:

    The question is "If you're paying 30% now ("up front" as you say), will you be paying 30% when you retire ("out back")? Will the Gov't raise taxes? Will you be paying 40%? Will you be in a lower tax bracket? Will we change to a "flat tax so everyone is in a 17% bracket? etc... Place yer' bets...

  • Report this Comment On April 09, 2013, at 10:38 AM, truman1987 wrote:

    One caution to jeb5904's rollover idea. If you currently have a deductible IRA, when you roll over the contribution you just made to your nondeductible IRA it will be counted as a percentage of the total of the nondeductible and deductible IRAs. You will pay taxes on the percent of the deductible IRAs.

    ex. You already have $10000 in a deductible IRA. You make a $5000 contribution to a nondeductible IRA and immediately roll it over into your Roth IRA. You will pay taxes on 2/3rds of the rollover.

  • Report this Comment On April 09, 2013, at 10:46 AM, truman1987 wrote:

    Note to Notso. Run a retirement calculator on saving via a tax advantaged IRA versus just saving in a taxable account. You will see that the money you make on the money that you are deferring taxes on will be a large amount by the time you take out the money 10-20-30 even 40 years from now. Even if your tax rate rises in retirement you will likely still be ahead.

  • Report this Comment On April 09, 2013, at 7:44 PM, xferjenx wrote:

    <i>Rule 1: Too much income means no Roth for you.

    The first rule to keep in mind is that some people aren't allowed to contribute to a Roth. For 2013, single filers with more than $127,000 in what's known as modified adjusted gross income can't make any contribution to a Roth, while those with incomes between $112,000 and $127,000 are stuck with reduced contributions. For joint filers, the similar limits are $178,000 and $188,000.</i>

    Echoing others' sentiments...if you have no other IRA's other than Roths and you income is above the phase out limits, you can open a Traditional IRA for you and your spouse, fund them both and immediately convert them to Roths with no tax consequences since there were no gains on the money placed in the Traditional Accounts before the conversions.

  • Report this Comment On April 10, 2013, at 1:16 AM, jakcrk wrote:

    For the average working man a traditional IRA makes for sense than a ROTH IRA, because of the deduction from your gross income should reduce you tax bill for the year, which will give you more spending money for each year you work. When you retire, the payout from your traditional IRA plus your social security payment will not impact your taxes that much because you won't have that much income. The government beats up the blue collar working man when you have a Roth because you are paying more tax to the government each year. However, any IRA is better than no IRA, just invest in one now for your future.

  • Report this Comment On April 10, 2013, at 11:08 AM, notsosmot wrote:

    Thanks to everyone for the comments. Actually, they confirm (to me) that I have not missed any knowledge or logic.

    Some people have difficulty saving money, and for them an IRA retirement plan is a necessity. That is not me.

    Maybe in the future we can have a go-around about stock options, which I suspect are also not a good idea.

  • Report this Comment On April 12, 2013, at 3:40 PM, WineHouse wrote:

    Note to "Notsosmot " -- be warned, that some of the contributors to this comment board (not all, but some) are even less smart than you, because they THINK they know the answers but they are wrong (mathematically challenged). You at least are asking the right questions. Some of the answers you have seen on this board are mistaken. Others are correct. How to tell the difference??? Aha, that's the hard part.

    Based on my own calculations, the best kind of IRA is the Roth, assuming that you will hold most if not all of the $$ inside the retirement account for at least 10 years. The longer you hold the $$ inside the account, the better off you will be. And if you are lucky enough to have $$ left over to leave to your heirs, if that money is in a Roth, your heirs will be better off also. The back-door Roth is basically a marvelous way for the truly wealthy to evade income taxes like gangbusters, leaving it up to the not-so-smart holders of traditional IRAs to pay the taxes for all the government services that the rich enjoy at least as much as the middle class.

    It's easy to make a sample calculation and compare the following three kinds of investments: 1, a "plain" investment account, with no tax advantage one way or another; 2, the same investment held inside a traditional IRA (2a=deductible and 2b=nondeductible or mixed); and 3, the same investment held inside a Roth. Take as a scenario something easy -- e.g., 25% income tax rate for all situations, and a one-time $10,000 individual corporate bond purchase with interest payments once a year at 10% for 20 years. Calculate what you have to pay in taxes at the time you put the $ into the account, and also what you accumulate over a 20 years period of time and then what you have to pay in taxes when you withdraw the total amount of $$ at the end of the 20 years. See and compare for yourself!

    Then, after you've done that, consider the following complicated but reality-based issue: if you have growth in a "regular" account that is based on either realized capital gains or "qualified" stock dividends, that income is tax-advantaged to you at the time you "realize" it (by that I mean that you pay much less tax on that income than your "top rate") whereas the same kind of income that was sheltered in a traditional IRA gets taxed at your FULL max tax rate when you draw it out. Depending on how long you've been deferring the tax on that income, the deferral may or may not be to your advantage. A long deferral period is definitely to your advantage (unless you've held nothing but Index funds in your account and just let them "ride" all those years, in which case you would have been much better off in either a Roth or no IRA at all than in a Traditional IRA). But, as you get older, you are required to take out a larger and larger percentage of a traditional IRA. Once you're in your 80's, you will be required to draw more than 6% -- and it will still be increasing each year -- and at that point you might wish you had your money in a "regular" account rather than the traditional IRA -- or even better,of course, in a ROTH.

  • Report this Comment On April 12, 2013, at 6:00 PM, carolsmithhsa wrote:

    Just a clarification about the five year rule as it relates to A Roth.

    The five-year rule and age 59 and 1/2 must be met in order ot take our Roth money totally tax free. However, the five year rule does not apply to 'the account' but to the earliest Roth IRA account and is measured from January 1 of that year. Many Roth IRA holders have more than one Roth IRA account and the tax-free-ness is measured against the oldest of the accounts bieng in force for at least 5 years.

  • Report this Comment On April 12, 2013, at 9:35 PM, UFOFred wrote:

    One more thought about a traditional IRA. When you are old, your healthcare expenses are likely to be much higher. So long as you can deduct these expenses**, you may be able to take traditional IRA income tax free or at least with minimal tax.

    ** The deduction threshold was recently raised for medical expenses from 7.5% to 10%, making medical deductions less useful. But if you are really sick or face nursing home costs, you may still be able to take a deduction.

    Of course, it is better to be healthy and pay the tax but things don't always work out that way.

  • Report this Comment On April 13, 2013, at 11:39 AM, earlyseller wrote:

    Who are the 'alleged' tax experts that can claim to be up to date on the current/latest law dealing with ROTH IRA distributions after age 59 1/2? My ROTH is over ten years old; latest contributions are over 3 years old and I want to transfer more IRA $ to the ROTH as I now flood damaged and low tax advantaged and old.

    Can new ROTH rollover from IRA be income spread backward and forward to average out taxable impact?

    WHO Knoweth the true answers?

  • Report this Comment On April 16, 2013, at 4:31 PM, TR1442 wrote:

    Rule 3 is not exactly as shown. I have been told that you must have "earned income" to open a Roth. So if you wait til after you retire you are blocked from opening a Roth or rolling an existing IRA over to a Roth.

  • Report this Comment On April 16, 2013, at 9:43 PM, OwlCreekObserver wrote:

    My wife and I are both retired and both drawing government pensions and social security. We both have regular IRAs and Roth IRAs that we've had for many years.

    What I can't get through my thick head is whether we can move our annual RMDs from the regular IRAs, pay the taxes, and put them into the ROTH IRAs. We have other investments outside of the IRAs so we don't need to withdraw the money at this point.

  • Report this Comment On April 18, 2013, at 1:10 AM, BxBruce007 wrote:

    "Rule 3 is not exactly as shown. I have been told that you must have "earned income" to open a Roth. So if you wait til after you retire you are blocked from opening a Roth or rolling an existing IRA over to a Roth. "

    This is a confusing issue which I have come up against. You cannot contribute to a Roth if you have no earned income (say you make all your income from investments, which might pertain to some folks on this site).

    BUT, what I have gotten conflicting answers on is can you rollover an IRA to a Roth even if you don't have earned income. I've been told yes, maybe and no.

    Of course, if you do that and your IRA has pretax dollars in it, you'll have to pay the taxes.

  • Report this Comment On April 18, 2013, at 1:58 AM, lostinchina wrote:

    Rule #1 is "technically" correct when talking about a Roth IRA. Howeve, if your employer has a 401K plan, they may have a "Roth" investment vehicle inside the 401K, which was allowed starting a couple of years back. Since I work over seas, and don't pay much US Federal Income tax due to the credit the IRA allows for all of the foreign taxes paid on my behalf by my employer, I don't need the tax break that the "IRA" vehicle in my 401K gives me, so I esenetiall put money in a Roth, but make well in excess of the MAGI limits for normal Roth accounts. Make sure to check if you employer has a Roth vehicle in there 401K. Neither my accountant or employer has ever told me I make too much to contribute to this Roth vehicle in the 401K program. When I retire, I'll roll the Roth from the 401K into another Roth account held by my borker.

  • Report this Comment On April 19, 2013, at 12:58 AM, raymondluk wrote:

    A little disclosure here: I work in the insurance and financial services so I deal with this first hand everyday. It does not mean I know everything, far from it. So I suggest you verify what I am about to share with you.

    I see many are confused about Roth IRA, and Roth conversion here. Let me chime in and hopefully provide you with clarity.

    About the debate on IRA/401K vs Roth IRA. It depends on your individual circumstances - tax, job situation, cash flow, time horizon, among other things. One thing I typically advises my clients is have both buckets and balance. You want to diversify not only your allocation, but also your tax buckets. Unless you have a crystal ball and can tell what lifestyle you will have, and tax brackets you will be in 5, 10, 20 years from now... and upon your retirement until you die, there is no "best" way. With money in different tax buckets, you can at least have some control over how much money you want to take out from your qualified bucket (IRA, 401K, etc) to support your desired lifestyle; and make up the rest with after tax bucket (saving, MM, brokerage) and tax free bucket (Roth IRA, muni bond, cash value life insurance *discuss this with a knowledgeable life insurance professional). The idea is you can manage your tax bracket by taking out from different buckets for the same dollar at retirement.

    For rules on Roth IRA contribution and conversion (you can read more on irs.gov), these are the technical overview.

    - You can use "backdoor" Roth conversion like some others suggested, even if you are over the income limit. I did one for my clients last week. Be mindful if you have other IRA accounts. Find a professional to help you with the cost basis.

    - You can only "open" a Roth IRA account if you have earned income. So if you are retired with no earned income, you cannot open one

    - You can however proceed with Roth conversion even if you have no earned income, as long as you have money to pay the tax on distribution - or tax will be taken out from your conversion acct.

    - upon RMD (required minimum distribution, age 70 1/2, unless you still have earned income), you can convert your IRA money to Roth IRA, but it does not count toward your RMD. So you will be required to do both. Double check this with your CPA. I have not done this prior, just what I remember.

    To lostinchina, some companies also have a Roth 401K plan. They have the same contribution limit as in regular 401K; but contributed with after tax money. Roth is not an investment vehicle. It is a tax "wrapper" with eligible type of investment inside, stock, bond, mutual fund, etc. The same kind of investments can also be in 401k and non-qualified account. They are just treated differently based on IRS code. In another word, there should not be a roth like investment inside a regular 401k plan.

    Hope that helps everyone.

  • Report this Comment On June 10, 2013, at 1:00 PM, KIDKAN wrote:

    When one takes out monies from his or her Roth account, how is reported, if at all, on tax records? Is it part of one's moodified adjusted gross income?

  • Report this Comment On February 13, 2014, at 5:10 PM, calboyincal wrote:

    If I started a roth under the income linit and the next year was atthe limit am I no longer able to contribute to this account?

  • Report this Comment On April 09, 2014, at 8:26 PM, Widow95 wrote:

    1) Husband and I opened Roth IRAs in 2007. 2013 his Roth IRA was inherited, and rolled over to my account (spouse/beneficiary). Does the 5 year rule for this rollover into my account start in 2013 for that money? Or is there an exception for spouses inheriting?

    2) I also inherited his 401K and rolled it into a new IRA under my name. Can I fund the Roth with stocks or do I need to cash the stocks, transfer the money and rebuy them in the Roth?

  • Report this Comment On April 10, 2014, at 9:13 AM, TMFGalagan wrote:

    @Widow95 - The five-year period is measured from when one opens the Roth, not when additional money moves into the Roth. On your second question, the answer is generally that you need to use cash to make contributions. But if you're doing a direct transfer, there may be a way to move assets - check with your financial provider.


    dan (TMF Galagan)

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