What is a Roth IRA?

There are plenty of retirement accounts available, but it’s important to find the solution that matches your retirement goals. One of the most popular options is the Roth IRA. Whether you’re 28 or 50, a Roth IRA can be a great retirement savings option. With flexibility and tax-free growth, this solution continues to be a favorite amongst American workers of all ages.

Consider the benefits and limitations of this retirement solution and determine if a Roth IRA will help you achieve your retirement goals.

Roth IRAs

A Roth IRA is a retirement savings account that’s funded with post-tax income. The contributions you make to a Roth IRA cannot be included as deductions on your income taxes, meaning this option doesn’t provide any initial tax benefit. Your Roth IRA is funded with after-tax dollars, so you’ve already paid taxes on the funds you put into it.

After you open a Roth IRA and make contributions, your investment will grow tax-free—when you do withdraw your funds (provided you’ve followed all Roth IRA regulations), there will be no income tax on the amount. This means every last cent goes straight to your wallet.

What’s the Roth IRAdifference between a Traditional IRA and a Roth IRA?

Roth IRAs offer more flexibility than a traditional IRA does. Traditional IRA contributions are tax-deductible on federal and state tax returns during the year you make the contribution, and your withdrawals in retirement will be taxed at current, ordinary income tax rates. Roth IRAs offer no tax break for contributions, but earnings and withdrawals are typically tax-free.

When can I make a penalty-free IRA withdrawal?

If you’ve had your Roth IRA for five years and you’ve reached age 59 ½, all of your Roth IRA withdrawals are penalty free. However, if you haven’t reached this age, or you’re passed the age limit but your Roth IRA has been open for less than five years, you’ll have to pay a 10 percent penalty for early withdrawals on your Roth IRA earnings.

Note: The 10 percent early withdrawal penalty applies only to the investment earnings for a Roth IRA, not the principle funds invested.

There are certain cases in which you can make an early withdrawal without facing any penalties (so long as you’ve had the Roth IRA for at least five years*):

  • You’re using the money to pay for higher education expenses for yourself, your spouse, your children or your grandchildren.
  • You’re using the withdrawal to pay for medical expenses greater than 7.5 percent of your adjusted gross income if you’re over the age of 65. If you’re under 65, the threshold increases to 10 percent.
  • You’re using the money to pay for a first-time home purchase (up to $10,000).
  • You’re paying for the costs of a sudden and unexpected disability.
  • You’re using the money to pay off tax debt.

*If you die before reaching this five-year marker, the IRS will tax your beneficiaries on distributed earnings until this condition is met.

What are the benefits of a Roth IRA?

Many choose Roth IRAs due to the extensive benefits they provide. What kind of benefits can you expect if you open a Roth IRA?

  1. Tax-free income in retirement: Once you reach retirement age, you can look forward to a stream of tax-free income from your Roth IRA. Uncle Sam doesn’t have any type of claim to your earnings—what you pull out is completely yours to do with as you will.
  2. Flexibility: Life happens, and if something comes up, you have the flexibility to withdraw money from your Roth IRA. Roth contributions can be withdrawn penalty-free at any time (although your investment earnings may be penalized for an early withdrawal). While early withdrawals aren’t recommended, they are available, which isn’t the case for traditional IRAs.
  3. You can continue to contribute after 70 ½: With a traditional IRA, you must stop making contributions after hitting 70 ½. Roth IRAs allow you to contribute as long as you want, regardless of age.
  4. It’s great for your beneficiaries: If you’re hoping to leave money to your children and grandchildren, a Roth IRA could be the right solution. It allows you to prepay taxes for your kids and their kids, meaning you leave beneficiaries tax-free income they can use for a lifetime.

How Death Affects a Roth IRA

If you’re the beneficiary of a Roth IRA, you’re able to withdraw the money tax-free. However, the IRA must first meet the five-year period; if it doesn’t, you’ll need to pay the taxes until that time threshold is met.

If you’re not the spouse of the deceased Roth IRA account owner, you must:

  1. Withdraw everything from the account by the end of the fifth year following their death.
  2. Begin withdrawals by Dec. 31 of the year you (the beneficiary) must take the first required distribution using your life expectancy or
  3. Begin withdrawals Dec. 31 of the year containing the fifth anniversary of the owner’s death, if earlier. The amount you must withdraw is based on your own life expectancy

If you’re a widow and have inherited the Roth account from your deceased spouse, you’re allowed to treat it as your own, and you won’t be required to make withdrawals.

What are the eligibility requirements for a Roth IRA?

Unfortunately, Roth IRAs aren’t available to everyone, as this retirement savings option has strict eligibility requirements.

First, you can only contribute to a Roth IRA if you’ve earned income from a job—monetary gifts or leftover loan money cannot be used as a contribution. Your income also limits your contribution. For example, if you make only $4,000 a year (i.e. a college student with a summer job), the most you could contribute to a Roth would be $4,000.

Roth individual retirement accounts aren’t available to high earners. The more money you make (after a certain threshold), the less you’re able to contribute. These contribution limits vary based on your filing status.

We’ve broken down the contribution limits for three filing status categories: Married filing jointly or qualifying widow; Single, head of household, or married filing separately (if you did not live with your spouse during the tax year); and Married filing separately (if you lived with spouse at any time during the tax year).

Consider the following charts to assess contribution limits for 2021:

Filing Status: Married filing jointly or qualifying widow(er)

2021 Modified Average Gross Income Maximum Contribution
Less than $198,000 $6,000 ($7,000 if 50 or older)
$198,000 to $208,000 Contribution is reduced
$208,000 or more No longer eligible

Filing Status: Single, head of household or married filing separately (if you did NOT live with spouse during year)

2021 Modified Average Gross Income Maximum Contribution
Less than $125,000 $6,000 ($7,000 if 50 or older)
$125,000 to $140,000 Contribution is reduced
$140,000 or more No longer eligible

Filing Status: Married filing separately (if you lived with spouse at any time during year)

2021 Modified Average Gross Income Maximum Contribution
Less than $10,000 Contribution is reduced
$10,000 or more No longer eligible

My income exceeds the eligibility limit. Is there any other way I can contribute to a Roth IRA?

Typically, those that make a high income cannot make contributions to a Roth IRA. However, if you’re above the income threshold, there are ways around this.

Some choose to make a nondeductible contribution to a traditional IRA, then convert it to a Roth IRA. This is commonly referred to as a back-door Roth. However, this can be a complex and confusing conversion, and it’s best done with the help of a professional.

Although high-income earners can convert to a Roth IRA, you may not be able to contribute additional funds, which we will discuss further in the next section.

Can I convert my Traditional IRA to a Roth IRA?

Yes, as previously mentioned, this conversion is called a back-door Roth IRA or Roth conversion.

In the past, you could only convert a traditional IRA to a Roth IRA if your income was under $100,000. Currently, there is no income cap on this conversion.

You may elect to keep your new account at the same financial institution, or switch to a new provider. Typically it’s easiest to send the IRA money directly to the new Roth provider instead of having it paid out. If you do choose to take it out, rollover rules require you must complete the transfer within 60 days.

If you make a Roth conversion, you’ll likely have to include the full amount transferred in your taxable income for the year. There is an exception to this rule, however. If you’ve made nondeductible contributions to your traditional IRA, the portion of funds that represents nondeductible contributions won’t be included in taxable income.

If you’re in a lower bracket, this conversion could help you lock into a lower tax rate. It’s important to speak with a qualified financial advisor before making this kind of conversion.

Note: If you’ve converted funds from a traditional IRA into a Roth IRA, you aren’t allowed to withdraw it penalty-free until at least five years after the conversion. Every traditional IRA you convert to a Roth IRA has its own five-year holding period.

Are Roth IRAs a popular option?

Roth IRAs are becoming a popular option for Americans in every stage of their career. While less than a third of all individual IRA accounts were Roth IRAs as of 2013, there’s been significant growth in the popularity of this retirement savings solution. According to the Employee Benefit Research Institute, there was a 51.6% increase in Roth IRA account balances between 2010 and 2013.

Roth IRAA Roth IRA could be one of the most valuable retirement tools available, and serves as a great tax shelter that can pay off immensely in the long run.

What if I already have a 401(k)? Can I roll over those funds to my Roth IRA?

If you’ve left a position of employment, and contributed to a 401(k) during your time there, you’re able to roll that balance over to an IRA—so long as the plan administrator allows this. In order to rollover your funds, you must be separated from that employer, unless you’re over the age of 59 1/2.

This rollover option is relatively new; prior to 2008, you weren’t able to rollover a 401(k) into a Roth IRA directly. Instead, you had to follow a two-step system: Open a traditional IRA, then convert that into a Roth IRA. Now, you can directly roll your 401(k) over to a Roth IRA, which simplifies the process.

Note: If you have a Roth 401(k), you won’t be required to pay taxes to roll the current balance into a Roth IRA as you’ve already paid taxes on the amount.

Why would I roll over my 401(k)?

Some choose to roll over funds from a 401(k) to a Roth IRA because it offers increased investment opportunities. There are certain situations that may drive an individual to rollover their 401(k):

  • You anticipate paying higher taxes in the future: Because Roth IRAs are funded by after-tax dollars, you’ll be required to pay taxes upfront on any contributions rolled over. However, when you withdraw those contributions down the line, you won’t have to pay taxes—this could be invaluable if you believe you’ll be taxed at a higher rate when you reach retirement.
  • You anticipate a higher salary: If you believe you’ll be making a significantly higher salary in the future, the time to rollover into a Roth IRA is now. After reaching a certain income, you’ll no longer be able to contribute to a Roth IRA. The more you earn, the harder it is to contribute to a Roth IRA.
  • You want withdrawal flexibility: Traditional IRAs require account holders to start taking withdrawals when they reach 70 ½, which are known as “required minimum distributions.” With Roth IRAs, you can withdraw long after this threshold.
  • You want to contribute after age 70 ½: Traditional IRAs don’t allow you to make contributions after 70 ½,—Roth IRAs do.

As indicated, there are many reasons you might choose to rollover your current 401(k) to a Roth IRA. If you have a 401(k), a rollover to a GuidedChoice managed IRA could help you achieve your retirement goals sooner. It’s easy to rollover; just give us a call or use our online evaluator to compare your current IRA fees to ours.

How much should I save to retire comfortably?

This question is hard to answer, as it depends on a variety of factors. Many financial experts agree that retirees will need around 80 percent of their pre-retirement salary after retiring (which includes income from Social Security, pensions, and other savings accounts).

According to the Economic Policy Institute, the mean retirement savings of working households aged 32 to 61 comes in at $95,776.

The amount you should save each year depends on your overall financial goals, but you should aim to put as much in your Roth IRA as allowed—the more you save now, the more tax-protected gains you’ll gather in the long run.

How to open a Roth IRA

Roth IRAIf you’re interested in opening a Roth IRA, let our team of experts help you get started today. The deadline for opening a Roth IRA account and making contributions is typically April 15 (tax day) of the following tax year. This date can sometimes come later due to holidays.

After opening a Roth IRA, you’ll have a few decisions to make. What sort of assets do you hope to hold? Are you interested individual stocks and bonds? Perhaps you’d prefer to function as a buy-and-hold investor. Your financial advisor can walk you through your options to find the solution that best suits your retirement goals.

It’s easy and convenient to open a Roth IRA with GuidedChoice. We’re seasoned professionals who can help you manage your contributions and investments, ensuring you get the most out of your retirement savings plan.