Roth IRAs are a great, tax-efficient way to save for your retirement.
What Is a Roth IRA?
A Roth IRA is a special retirement account that you fund with post-tax income (you can’t deduct your contributions on your income taxes). Once you have done this, all future withdrawals that follow Roth IRA regulations are tax free.
There is no up-front tax deduction for Roth IRA contributions, as there is with a traditional IRA, On the other hand, Roth distributions are tax-free when you follow the rules. And because every penny you stash in a Roth IRA is your money—not a tax-subsidized gift from Uncle Sam—you can tap your contributions (but not your earnings on those contributions) at any time, tax-free and penalty-free.
Like beauty, the benefit of a Roth IRA is in the eye of the beholder. It all depends on the beholder’s tax bracket—both now and when he or she retires.
Roth IRAs make the most sense if you expect your tax rate to be higher during retirement than your current rate. That makes Roth IRAs ideal savings vehicles for young, lower-income workers who won’t miss the upfront tax deduction and will benefit from decades of tax-free, compounded growth.
“As an example, if a 20-year-old puts $5,000 a year into a Roth for 10 years and then stops contributing (because they make more than the phase-out amount or need a tax deduction of future contributions to a Traditional retirement account), the 10 years of Roth contributions and growth—let’s say at 8% interest a year to age 65—could total about $1,070,944 of tax-free dollars,” says Peter J. Creedon, CFP®, ChFC®, CLU®, chief executive officer, Crystal Brook Advisors, New York, N.Y.
“Planning opportunities exist for parents and grandparents in that they can fund the Roth for a young person in years that they earn income but don’t make enough to save to the Roth,” says Elyse Foster, CFP®, principal, Harbor Financial Group, Inc., Boulder, Colo.
Roth IRAs also appeal to anyone who wants to minimize their tax bite in retirement, as well as older, wealthier taxpayers who want to leave assets to their heirs tax-free. (Unlike Traditional IRAs, there are no required minimum distributions [RMDs] on Roth IRAs, so well-funded retirees can leave their Roth money untouched if they don’t need it.)
“A Roth IRA can be a fantastic savings and investment vehicle because it provides tax-free growth and qualified withdrawals,” says Daniel Schutte, MBA, independent personal wealth manager, Credo Wealth Management, Denver, Colo. “If your income is not higher than the IRS limit, and you anticipate being in a higher tax bracket later or wish to avoid RMDs in order to keep your funds invested, a Roth IRA may be your best long-term savings option.”
You can contribute to a Roth IRA at any age as long as you have earned income from a job. That means they are appropriate for everyone from child actors to septuagenarian Wal-Mart greeters.
Are You Eligible?
First things first. Roth IRAs have income eligibility limits, so if you make too much money, you can’t contribute to a Roth IRA. But with a 2016 median household income of just over $59,000, according to a 2017 report from U.S. Census Bureau, most Americans qualify for Roth IRA contributions. (If your income is too high, you can convert some or all of the assets in your traditional IRA to a Roth IRA, but you’ll have to pay taxes on the entire amount you convert. For details, see more on Roth IRA conversions).
For the 2018 tax year, here’s what you can put in a Roth IRA, depending on your income, age and tax-filing status.
To contribute the maximum
You can contribute the maximum $5,500 to a Roth IRA ($6,500 if you are age 50 or older by the end of the year) if you are single or the single head of a household and your modified adjusted gross income (MAGI) is less than $120,000.
If you are married filing jointly, you can contribute the maximum amount to a Roth IRA if your MAGI is less than $189,000.
To make a partial contribution
At higher income levels, you can contribute less, based on a formula devised by the IRS. The relevant income figures:
You are single and your MAGI is between $120,000 and $135,000.
You are married filing jointly and your MAGI is between $189,000 and $199,000.
You can’t contribute to a Roth IRA at all if your income is above those levels.
Special rules apply to married couples who live together at any time during the year, but file separate tax returns. Neither can contribute to a Roth IRA if their income exceeds $10,000.1
|2018 Roth IRA Income and Contribution Limits|
|Filing Status||MAGI||Contribution Limit|
|Married filing jointly||Less than $189,000||$5,500**|
|$189,000 to $198,999||Begin to phase out|
|$199,000 or more||Ineligible for a direct Roth IRA (learn more about a “Backdoor Roth IRA”)|
|Married filing separately|
|Less than $10,000||Begin to phase out|
|$10,000 or more||Ineligible for a direct Roth IRA (learn more about a “Backdoor Roth IRA”)|
|Single||Less than $120,000||$5,500**|
|$120,00 to $134,999||Begin to phase out|
|$135,000 or more||Ineligible for a direct Roth IRA (learn more about a “Backdoor Roth IRA”)|
** Individuals who are 50 and older can contribute an additional $1,000 per year.
One caveat: If you earn less than the maximum contribution limit, you can contribute only as much as you earned. If, for example, you earned just $3,000, you could contribute only $3,000 to a Roth IRA for the year. Non-working spouses can contribute the maximum amount to a Roth IRA as long as the working spouse earns enough to cover the contributions to both accounts and the household income doesn’t exceed the IRS income-eligibility limits. Learn more about Spousal IRAs.
Beyond tax rates, some unique features of the Roth may influence your decision about whether to contribute to a Roth IRA.
- Flexibility: You can withdraw your contributions at any time without taxes or penalty. Although you normally must hold the Roth account for at least five years and be at least 59½ before you can tap the earnings tax-free and penalty-free, there are exceptions, including death or disability of the account holder or to use up to $10,000 to purchase a first home for yourself or certain family members. In addition, you can avoid the 10% early withdrawal penalty, but will still incur income taxes, if you withdraw earnings early to pay higher-education costs for yourself or a family member.
- No mandatory withdrawals: Roth account holders are never forced to withdraw money (Traditional IRAs require withdrawals beginning at age 70½). This is particularly useful for estate-planning purposes because it allows the account balance to continue to grow. Heirs pay no income taxes on inherited Roth IRAs, but they are required to take distributions over their lifetimes.
- Saving during retirement: You can make contributions to a Roth if you continue to work past retirement age, as long as you stay within the income limits. “Workers over age 70½ cannot make Traditional IRA contributions, so unless they have access to a retirement plan at work, the only option for investments that grow tax-advantaged is within a Roth IRA. Otherwise, savings would need to be placed in a taxable account,” says Jillian C. Nel, CFP®, CDFA, principal, Legacy Asset Management Inc., Houston, Texas
Wish you had contributed to a Roth IRA for the 2017 tax year? If you haven’t already, start now for 2018. You have until April 15, 2019, to make your contribution for 2018.
1 Roth income eligibility limits are not affected by coverage by an employer retirement plan. Those limitations apply only to tax-deductible-contributions to Traditional IRAs.