The Roth IRA (individual retirement account) can be an attractive savings vehicle if you want to lock in tax-free income during retirement. You can pay your tax bill now and enjoy a pile of tax benefits later. But here's the downfall: You won't be able to make direct contributions to a Roth IRA if you make too much money. If your income unexpectedly tips over the threshold, you'll have to take action immediately to avoid penalties.
Before you throw your money into a Roth IRA, here are a few requirements you should be aware of to avoid any unwanted surprises later.
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Know your contribution limits and income status
The Roth IRA allows you to fund your account with after-tax dollars so you don't have to worry about paying taxes ever again so long as you follow the rules. If you need the money before retirement, you can take a qualified distribution and use the funds to pay for college or buy a home. Also, there are no restrictions on the money you have already contributed to the account. You can withdraw your contributions whenever you want without penalties.
Although the Roth IRA benefits are appealing, there are limits that can get in your way. Let's dive into the contribution limits first.
For 2022, individuals under 50 can't contribute more than $6,000 to a Roth IRA. After you hit 50, you can tuck away an extra $1,000. The contribution limits are lower than what you would find in an employer-sponsored plan like a 401(k) or 403(b).
Before you add money to your Roth IRA, make sure you fall within the income thresholds for your filing status. For 2022, your modified adjusted gross income (MAGI) has to be less than $129,000 if you're filing single (under $204,000 if married filing jointly) to contribute the maximum amount to your account. Head of household filers have the same income limits as single filers. If your income exceeds those amounts, you may still be able to make reduced contributions to a Roth IRA.
Proceed with caution when you enter the phaseout range
Contributions can get a bit tricky after you enter the phaseout income range. If you're a single filer in 2022, your contribution limits drop after your income lands between $129,000 to $144,000. When your income soars beyond the phaseout ranges, you won't be eligible to make a direct contribution to a Roth IRA.
Here are the 2022 and 2021 phaseout ranges by filing status:
|
Filing Status |
2022 Income Range |
2021 Income Range |
|---|---|---|
|
Single or head of household |
$129,000 to $144,000 |
$125,000 to $140,000 |
|
Married filing jointly |
$204,000 to $214,000 |
$198,000 to $208,000 |
Data source: IRS.
There's a price if you contribute beyond the limits
It's important to pay attention to the phaseout ranges so you don't contribute more than what's allowed. The IRS doesn't take excess contributions lightly, and they can charge you a 6% penalty. That applies to every year you leave the excess contributions in your Roth IRA. Let's say you made excess contributions of $2,000. You'll end up paying the IRS $120 every year the additional amount remains in your Roth IRA.
If you find yourself in this situation, you should look at ways to correct the problem. You may have made an honest mistake, but the IRS isn't going to give you special treatment.
Don't ignore the Roth IRA qualifications
The Roth IRA provides an appealing offer, but you may not be eligible to make direct contributions if you earn too much money. You'll have to look at alternative ways to get your money into the account after your income tips over the limit.
That's why it's important to contribute as much as you can to the Roth IRA while you qualify. You'll be able to stuff your portfolio with assets that can help you secure tax-free gains and income during retirement without having to worry about penalties.
