On the road to retirement savings, not all accounts are created equal. In fact, there's one in particular that offers a world of benefits, and it's none other than the Roth IRA.
Established by the Taxpayer Relief Act of 1997, the Roth IRA got its name from its primary legislative supporter, Sen. William Roth of Delaware. Since its inception, over 50 million workers have been saving for retirement using a Roth IRA. If you're curious about how a Roth works, here are some answers to your most pressing questions.
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1. How much can I contribute to a Roth IRA?
Roth IRAs are subject to the same annual contribution limits as traditional IRAs. While these limits can change year after year, for 2017, anyone under 50 can contribute up to $5,500 annually. Workers who are 50 and older, however, get a catch-up provision that bumps the current limit up to $6,500.
2. Will I get a tax break for contributing?
Unlike traditional IRAs, which are funded with pre-tax dollars, there's no immediate tax break for putting money into a Roth IRA. But make no mistake -- Roth IRAs offer a host of tax benefits that traditional IRAs do not.
Once you fund a traditional IRA, your investments get to grow on a tax-deferred basis, which means you won't pay taxes on your gains year after year. Rather, you'll be taxed on your withdrawals once you begin removing money from your account in retirement. Roth IRAs, however, offer tax-free distributions in retirement, and tax-free growth along the way.
In this regard, Roth IRAs offer a number of key protections to retirees. First, if you have a Roth, you can rest easy knowing that all of the money in your account is yours to withdraw and use as you please; you won't have to worry about tax planning or withholding funds for the IRS. Second, because we don't know what tax rates will look like in the future, a Roth essentially eliminates the risk of falling into a higher bracket than expected later in life.
3. Do Roth IRAs have required minimum distributions?
Most tax-advantaged retirement accounts don't allow you to lock your money away indefinitely. Rather, you're required to start taking minimum distributions once you turn 70 1/2. This holds true for traditional 401(k) plans and most IRA types. The beauty of Roth IRAs is they don't come with required minimum distributions (RMDs), which means that if you don't need your money right away in retirement, you can leave it in your account and continue to benefit from that tax-free growth we talked about earlier.
4. When can I withdraw money from a Roth IRA?
The purpose of an IRA is to save for retirement, but sometimes account holders need to get at their money sooner. If you have a traditional IRA, you'll typically face a 10% early withdrawal penalty if you remove funds prior to reaching age 59-1/2 unless you qualify for a specific exception. With a Roth IRA, however, you can withdraw your principal contributions at any time and for any reason -- no questions asked. You don't need to worry about reaching a certain age or meeting the right criteria for an early withdrawal.
Notice, however, that this option applies to your principal contributions only, not your gains. The reason? Because Roth IRAs don't offer that immediate tax break, the IRS sees no reason to penalize savers for removing money they've already paid taxes on. Say you contribute $5,000 to a Roth IRA in a given year, and by the time you need to withdraw funds three years later, you're looking at a $6,000 balance thanks to your investments' performance. At that point, you'd have no problem removing your initial $5,000, but if you withdraw any of that additional $1,000, you could face an early withdrawal penalty.
5. Are there income limits for a Roth IRA?
If there's one drawback to the Roth IRA, it's that higher earners typically aren't eligible to fund an account. Here's what the 2017 income limits look like for Roth contributions:
|
Tax Filing Status |
Phase Out Begins At: |
No Contributions If Your Income Exceeds: |
|---|---|---|
|
Single |
$118,000 |
$133,000 |
|
Married filing jointly |
$186,000 |
$196,000 |
DATA SOURCE: IRS.
If your income renders you ineligible for direct Roth IRA contributions, worry not -- thanks to what's known as a backdoor Roth IRA, you can fund a traditional IRA and then convert that account into a Roth. Now if you go this route, you will have to pay taxes on the amount you move over the year you initiate your conversion, but the eventual tax savings could make this move more than worthwhile.
Opening a Roth IRA could be the smartest retirement move you'll ever make. And the sooner you get started, the more you stand to benefit in the long run.
