Roth IRAs

Roth Individual Retirement Accounts (IRAs) are a great tool to save for retirement, but what exactly is it and why would it make sense to use one?

What is it?

Simply put, a Roth IRA is an individual retirement account that allows the owner to contribute post-tax dollars to the account. The money in the account grows tax free and is withdrawn tax free after age 59 ½. This is different from a traditional IRA where you don’t pay tax on the money put into the account, but you are taxed when you take money out of the account. Because your money grows tax free, the difference between a Roth and a traditional IRA can be a difference of hundreds of thousands of dollars.

Who can open a Roth IRA?

Anyone who has earned an income and who’s modified adjusted gross income is under $129,000 ($204,000 for married, joint filers) in 2022 can open and contribute money to a Roth IRA. If your spouse earns little or no income and you file taxes jointly, you may open a spousal Roth IRA and contribute to it on their behalf.

If your income is above the annual limits set by the IRS, you may not contribute directly to a Roth IRA, but you can still fund an account through a backdoor Roth conversion. Consult with a financial professional to see if it’s a good fit for you.

Withdrawal Rules

Roth IRAs help you pay less in taxes because the government wants you to save money for retirement. The advantage of a Roth IRA is you can always withdraw your contributions from your account tax-free and penalty-free. However, because the government wants you to use the money for retirement, you will pay a penalty and tax on any earnings you withdraw unless the withdrawal is used for specific reasons. Withdrawing money is also called a distribution. Think of it as the account is paying you a distribution. To avoid taxes and penalties, your distribution needs to be qualified or meet certain exceptions.

To be qualified, your Roth account must have been open for 5 years and you are withdrawing money because you meet one of these criteria:

• You are 59 ½ years old
• You’re withdrawing up to $10,000 for a first-home purchase
• You become totally and permanently disabled.
• You died, and money is being paid to your estate/beneficiary

If your distribution is not qualified, then you will pay a 10% penalty on the total distribution amount and income taxes on any earnings you withdraw. To avoid the 10% penalty, your distribution must be made for the following situations:

• You are totally and permanently disabled.
• You are the beneficiary of a deceased IRA owner.
• You use the distribution to buy, build, or rebuild a first home.
• The distributions are part of a series of substantially equal payments.
• You have unreimbursed medical expenses that are more than 7.5% of your AGI (defined earlier) for the year.
• You are paying medical insurance premiums during a period of unemployment.
• The distributions aren’t more than your qualified higher education expenses.
• The distribution is due to an IRS levy of the IRA or retirement plan.
• The distribution is a qualified reservist distribution.

To avoid paying taxes on your earnings for a non-qualified distribution, your Roth IRA account must have been opened for at least 5 years and your distribution has to meet one of the exceptions listed above.

Roth IRAs have no required minimum distributions, which means you never have to take money out of the account if you don’t need it.

The cost of early withdrawal

Saving for retirement is a great thing, but there are times where we struggle to make ends meet today. A Roth IRA has several ways in which you can withdraw money, but using that money today means it won’t continue to work for you. But what’s the real cost to you? If you were to withdraw $10,000 from your account at age 30, assuming a 6% return and you let the money grow until 65, you would be forgoing $140,000 that your $10,000 could have earned for you. Before making early withdrawals from your retirement account, consult with a financial professional to see what your options are.

Tip to Know:

• Compounding interest is powerful. To take full advantage of it, start saving early and let your accounts grow without withdrawing money.

Key Takeaways

A Roth IRA can be a great retirement vehicle, especially for young earners to take advantage of their lower tax bracket. It allows your money to grow tax free and be withdrawn tax free for qualified distributions. It does not have required minimum distributions, which helps you not have to take money out when you don’t need it.

If you have any questions on how to best prepare your family for the future, one of our advisers would be happy to help!

Only an investopedia article mentioned this; everything else seems that you still have to pay income tax on earnings if it’s non-qualified