There's no substitute for saving if you want a financially secure retirement. Social Security can help you get part of the way there, but you'll need your own nest egg in order to cover unexpected expenses and add spice to your retirement lifestyle.
However, many people focus on the wrong thing when they save for retirement, and part of the blame goes to the federal government. By offering up-front tax breaks for contributions to traditional IRAs and 401(k) plans, the IRS gives people an immediate incentive to favor those types of retirement accounts. As a result, a smaller number of taxpayers pursue Roth IRAs than traditional IRAs. But due largely to the changes in tax rates in the past couple of years, the advantages of Roth IRAs are even clearer for many people.
Why Roth IRAs deserve more attention than they get
The biggest advantage that a Roth IRA has over a traditional IRA is that it gives you the ability to save and invest on a tax-free basis. Not only do you not pay taxes on income and gains while the assets remain in the account, but you also typically won't have any tax liability when you make qualified withdrawals from the Roth IRA in retirement.
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In order to get that benefit, though, you have to give up something that traditional IRAs and similar accounts give you: a tax deduction in the year in which you contribute. In essence, what you're doing with a Roth IRA is choosing to take on a bigger tax burden in the current year in the hope of saving a lot more in taxes down the road.
Before the latest changes to tax rates, that inherent trade-off led to different actions from different people. With old rates that went as high as 39.6% and with additional surtaxes on top of that, the value of those up-front deductions was quite large, especially for high-income taxpayers.
Now, lower tax rates make it more likely that your current tax burden is lower. By using a Roth, you can effectively lock in those low tax rates and make it so you won't have to pay taxes ever again on your contributions. That's especially worthwhile if you think that there's a chance that tax rates will go back up at some point between now and when you retire.
Can you contribute to a Roth IRA?
One reason why fewer people use Roth IRAs than traditional IRAs is that Roth IRAs limit who can make contributions. First, like any IRA, you have to have earned income from a job or self-employment in order to make a contribution to a Roth IRA. Maximum limits for 2019 and 2020 are $6,000 for those younger than 50 or $7,000 for those 50 or older. But if you have less in earnings than those amounts, you can only contribute what you've earned for the year.
The more common obstacle involves maximum income thresholds. If you have too much adjusted gross income, then your ability to contribute can be reduced or eliminated entirely. Below, you'll find the income limits that apply to Roth IRA contributions for 2019 and 2020.
|
For This Filing Status: |
Contributions for 2019 Phase Out in This Range |
Contributions for 2020 Phase Out in This Range |
|---|---|---|
|
Single, head of household, or married filing separately IF you didn't live with your spouse during the year |
$122,000 to $137,000 |
$124,000 to $139,000 |
|
Married filing jointly or qualifying widow or widower |
$193,000 to $203,000 |
$196,000 to $206,000 |
|
Married filing separately IF you lived with your spouse at any point during the year |
$0 to $10,000 |
$0 to $10,000 |
Data source: IRS.
What that means is that above the upper end of the range, you can't make a contribution at all. If you're within the range, the amount you can contribute gets prorated. For example, if you're under 50 and single with $132,000 in adjusted gross income for 2019, then your maximum contribution for 2019 will be $2,000. That's because your income is two-thirds of the way up the range, and so you have to reduce the $6,000 baseline maximum contribution by two-thirds, or $4,000. That leaves you with a $2,000 contribution limit.
Make a Roth IRA your New Year's resolution
There's no need to wait to make a 2019 Roth IRA contribution, but there's also no imminent need to hurry. The deadline for 2019 contributions isn't until April 15. So once January rolls around, you could potentially make a double contribution that combines 2019 and 2020 amounts.
With low tax rates coming from recent tax cuts, Roth IRAs look more attractive than they have in a long time. But with constant uncertainty in Washington about the future of taxes, capitalizing on this opportunity sooner rather than later for your retirement planning could be the best move you can make.
