The time between January 1st and mid-April is a key "clean-up" time for people to review their financial activity for the previous year. But how does your Roth IRA play into this?
Here, we'll discuss how to make the most of your Roth IRA before taxes are due.
You have until April 18th to make 2021 contributions
One of the fortunate aspects of retirement contribution rules is that you have some extra time to make retroactive contributions to IRA accounts. In other words, you have the tax filing deadline in the following year to make contributions that "count" for the previous tax year.
For instance, because of a holiday-related extension, you have until April 18th, 2022 to contribute to your Roth IRA for the 2021 tax year -- up to the IRS-prescribed limit of $6,000, or $7,000 if you're over age 50.
Note that once you max out your Roth IRA contributions for 2021, you can then focus on making contributions for 2022. In total, that's $12,000 worth of space available for both years, and $24,000 if you're married (as both you and your spouse can open their own accounts with their own separate limits).
Whether you can contribute directly to a Roth IRA depends on your overall income; if you earn over a certain amount, you're not eligible for direct Roth contributions. If you're in that camp, you might look into the backdoor Roth IRA to circumvent this rule.
Reserve your Roth IRA for your highest- growth assets
Many of us have heard about Peter Thiel's five billion dollar Roth IRA, which was initially started with private shares of Paypal. While this is probably not a fair expectation for most everyday investors, it does give an example of how explosive growth in the Roth IRA shelter has especially important meaning: Not only did Thiel see these shares grow to astronomical heights, but the entire account will remain tax free for the rest of his life.
This is all to illustrate one important point: Roth investments should be those with the highest growth expectations. For some, that may mean a stock index fund; for others, it might mean shares of early-stage start-ups. In either case, it's critical to know that the Roth represents an opportunity, and one that will grow exponentially with the right assets.
Investments like cash and bonds would generally be inappropriate for a Roth; stock shares with a growth trajectory are more suitable.
Ensure it passes through your estate properly
One of the commonly forgotten steps of the Roth IRA process is to properly assign beneficiaries, which helps to ensure that the account will remain tax free for as long as possible.
A Roth IRA left to a spouse who treats it as their own account wouldn't trigger required minimum distributions ("RMDs"), thereby allowing the account to remain tax exempt at least until the death of the second spouse.
Depending on who ultimately inherits the account, the recipient will have to take required distributions that map to a certain schedule. Even though Roth IRA distributions wouldn't be taxable, the money will ultimately need to exit its tax-protected space.
The key is to ensure you have your beneficiaries lined up properly, which, if you have a simple family structure, may take only a few minutes. If your situation is more complex, it's worth visiting an estate planning attorney to ensure your Roth IRA passes in a tax-efficient manner.
Make the most of your Roth IRA
Even though the Roth IRA is known to have relatively modest contribution limits, consistent additions and smart investment choices can allow the account to compound at a staggering rate. Over the span of many decades, a well-managed Roth IRA stands to benefit both your retirement plan as well as the lives of your heirs.
If there's anything we can count on, it's that taxes are uncertain; with a Roth IRA, you have a chance to evade the uncertainty. Give yourself a zero tax bill for the next several decades and let the chips fall where they may.