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Why is a Roth IRA Awesome!

Roth IRA is a term that I’m sure you have heard before, but may not necessarily understand. So, let’s take a few minutes to talk about them, clarify and excite!

A Roth IRA is an individual retirement account. You contribute to a Roth IRA with earned income. What makes Roths awesome is that your contributions grow tax deferred and are withdrawn tax free!

For example, if you contribute $5,000 to your account this year, perhaps that contribution will grow to $30,000 in 10 years. You ONLY pay taxes on the initial $5,000 contribution. You do not pay taxes on the $25,000 growth. 

I often get asked by clients if they should contribute to an IRA instead of a Roth or vice versa.

The rule of thumb is:

  • Those that contribute to a Roth believe their taxes are lower now than they will be in retirement. Keep in mind that even if your income is going to be lower in retirement, you may still be in a higher tax bracket, or pay a higher tax rate due to legislation at that time. So, pay taxes now for the benefit of not having to pay taxes again.
  • Traditional IRAs are the opposite. You contribute to a Traditional IRA with pre-tax dollars. You’ll pay taxes when you withdraw – in retirement.
Contributions to Roth IRAs do have some limitations.
  • If you are under 50 years old, in 2021, you can only contribute $6,000 a year.
  • If you’re older than 50, you can contribute the $6,000 plus an extra $1,000 “catch-up” contribution.
  • You are unable to contribute to a Roth IRA if you make too much money. In 2021, making “too much money” is defined as being single and making more than $140,000 or married and making more than $208,000.
Have you heard of a Back-Door Roth?

You can always convert an IRA to a Roth IRA, even if you earn above those income limitations. This is called a back-door Roth. You will have to pay taxes on any IRA amount that you convert to a Roth IRA, but once the money is converted, you will enjoy tax deferred growth and tax free retirement distributions. You can even convert an IRA to a Roth, the same year your contribution is made. 

Other fun facts about Roth IRAs
  • You can only contribute to a Roth with earned income. For example, if your earned income was $4,000, the maximum you can contribute to a Roth IRA is $4,000. Earned income does not include:
    • Rental income or other profits from property maintenance
    • Interest income
    • Pension or annuity income
    • Stock dividends and capital gains
  • They are not tax deductible, unlike Traditional IRAs. 
  • At any time, you can withdraw your contributions. For example, if you contribute $5,000 to your Roth and it grows to $11,000, you can withdraw the $5,000 contribution at any time and not pay taxes or penalties.
  • You may withdraw more than your contribution but there are taxes and penalties if you don’t follow the rules.
    • The account must be established for at least 5 years.
    • The Roth IRA holder is at least age 59½ when the distribution occurs.
    • The distributed assets are used toward the purchase—or to build or rebuild—a first home for the Roth IRA holder or a qualified family member (the IRA owner’s spouse, a child of the IRA owner and/or of the IRA owner’s spouse, a grandchild of the IRA owner and/or of their spouse, a parent or other ancestor of the IRA owner and/or of their spouse). This is limited to $10,000 per lifetime.
  • The distribution occurs after the Roth IRA holder becomes disabled.
  • The assets are distributed to the beneficiary of the Roth IRA holder after the holder’s death
  • Contributions can be invested in mutual funds, brokerage accounts, annuities, money markets and more.

Whether you expect taxes to be higher or lower in retirement, let’s talk! I can help create a Roth IRA strategy to generate tax-free retirement income. 

Have you made your 2020 IRA contribution?

If not, don’t despair! You can make 2020 IRA and Roth contributions up until you file your taxes in April. 

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