A Roth IRA (Individual Retirement Account) is a type of retirement investment account. This is separate and apart from your employer provided retirement options. Instead, it is an account that you may be able to independently open at any major brokerage firm.
Simply put, there is NO other investment vehicle like the Roth IRA.
Why? Well, because all of the income earned within the account grows tax free AND future withdrawals will be taken out tax free assuming that certain guidelines are followed (see guidelines below).
Tax free growth is POWERFUL when you look at the impact on an account over a long period of time.
Imagine investing $6,000 within a Roth IRA today, investing it into an S&P 500 Index Fund and never touching it again. Assuming an average annual rate of return of 10%, after 30 years that $6,000 Roth IRA account would grow to $104,697. That’s $98,697 of growth from your original investment that you will never have to pay tax on.
Powerful. Tax efficient. Incredible wealth building opportunity.
Below you will find all the information you need to understand the Roth IRA, how it works, why I’ve always been a huge fan, determine if you are eligible and decide if it may make sense for you as an investor!
What Are the Major Benefits of Having a Roth IRA?
- Tax FREE growth and tax FREE withdrawals
- Flexibility in the use of funds. Your withdrawals are to be used at your discretion and do not have to be used for a specific purpose – like education, health, etc.
- No required minimum distributions. You are not forced to withdraw funds at a particular age like you would be if you had a Traditional IRA or traditional employer retirement plan. With that said, the Roth IRA could be used as a substantial generational wealth transfer tool.
Refer to a previous blog post: 4 Keys Benefits of a Roth IRA
Are You Eligible to Contribute to a Roth IRA?
There are two different requirements in order to be eligible to contribute directly to a Roth IRA.
- INCOME LEVEL
- Your income must be below the income thresholds determined by the IRS. Income Limitations – See below.
- Your income must be below the income thresholds determined by the IRS. Income Limitations – See below.
- EARNED INCOME
- You must have earned income – salary, wages, compensation in some form. The exception to this rule is related to a Spousal IRA. If you have a spouse that is a stay at home parent or spouse, refer to this blog post to learn more.
- You must have earned income – salary, wages, compensation in some form. The exception to this rule is related to a Spousal IRA. If you have a spouse that is a stay at home parent or spouse, refer to this blog post to learn more.
Income Limitations:
Your income eligibility is based on your MAGI or Modified Adjusted Gross Income on your tax return. Your MAGI accounts for all of your income sources – salary, investment income, business income, etc. and is offset by a few deductions. 2022 and 2023 Roth IRA Income Limitations are as follows:
Single Tax Filer:
2022 Income Thresholds:
- MAGI less than $129,000 – Eligible for max contribution
- MAGI between $129,000 – $144,000 – Contribution limited as income increases
- MAGI greater than $144,000 – No longer eligible to contribute
2023 Income Thresholds:
- MAGI less than $138,000 – Eligible for max contribution
- MAGI between $138,000 – $153,000 – Contribution limited as income increases
- MAGI greater than $153,000 – No longer eligible to contribute
Married Filing Jointly Tax Filer:
2022 Income Thresholds:
- MAGI less than $204,000 – Eligible for max contribution
- MAGI between $204,000 – $214,000 – Contribution limited as income increases
- MAGI greater than $214,000 – No longer eligible to contribute
2023 Income Thresholds:
- MAGI less than $218,000 – Eligible for max contribution
- MAGI between $218,000 – $228,000 – Contribution limited as income increases
- MAGI greater than $228,000 – No longer eligible to contribute
BUT WAIT, don’t be discouraged if your income is too high to directly contribute to a Roth IRA. This is a good problem to have after all. Consider looking into the Backdoor Roth IRA Method to get around those income restrictions.
Who Should Be Considering a Roth IRA?
The Roth IRA account is one that I could make a strong argument for many individuals to prioritize investing within. Here are a few scenarios in which you may want to consider it for yourself.
For Individuals :
- Despite your age, if you are under the income threshold, earning money and have a longer than 5 year investment time horizon – Opening or contributing to a Roth IRA should be up for consideration.
- If your 401K and employer provided retirement plan fees are significant and/or they only offer a Traditional 401K, consider the Roth IRA. After contributing up to the employer match, it may be worth considering shifting to the Roth IRA to benefit from reduced fees if you were to invest on your own AND the tax free growth within the Roth IRA. After the Roth IRA is maxed, you could then shift back to maxing out your 401K.
- If you are 60+, still working, have no intention of retiring soon, and have no need for some of the cash you have on hand for years to come – you could be considering a Roth IRA.
For Parents:
- If you are a parent and your child is earning income from their first job or summer job – you are able to open an account on their behalf as a custodial Roth IRA and begin adding to it.
- If you are self employed and a parent and want to “employ” your children to do things for the business like postage, modeling retail items, organization, filing, etc. You could hire your children so that they earn an income, you would benefit by having a business deduction and in turn you could open a custodial Roth IRA on their behalf to contribute to.
I could go on and on here but I think you get the idea, right? The Roth IRA is arguably one of the best investment vehicles to invest within and should at least receive your consideration.
How Do Roth IRA Contributions Work?
- Annual Maximum Contributions:
- Per 2022 IRS guidelines, you are able to contribute up to $6,000 per year into an IRA account. $7,000 if you are 50 or older.
- Per 2023 IRS guidelines, you are able to contribute up to $6,500 per year into an IRA account. $7,500 if you are 50 or older.
- You are able to contribute to a Roth IRA account as well as a 401K (or any employer sponsored retirement plan). They are two entirely different investment entities.
- You are not able to contribute in excess of the maximum contribution to any IRA account. For example, if you have a Traditional IRA and a Roth IRA – you are able to contribute $6,000 in total, not $6,000 to each.
- After you contribute into the Roth IRA, you then must INVEST! I have seen too many clients, friends and family tell me that they contributed but never invested. Please invest the money that you have contributed within the account! That is the only way to actually receive the full benefit of the Roth IRA.
How Do Roth IRA Withdrawals Work?
- You are able to withdraw funds from a Roth IRA after age 59 1/2 – penalty and tax free if you have held the account for a minimum of 5 years.
- If you withdraw money from a Roth IRA prior to turning 59 1/2, and not for a reason related to one of the exceptions below, you will trigger a 10% penalty. You may also be responsible for paying tax on the earnings you generated in the account depending on how long you have held the account for. (Must hold for 5+ years)
- There are no required distributions (in a 401K or Traditional IRA, you are required to begin taking minimum distributions at age 72). A Roth IRA does not have these requirements and thus could grow for years and be used as a generational wealth transfer tool.
- **You are able to withdraw your original contributions at any time, penalty and tax free.**
What If I Need the Money Prior to Age 59 1/2?
Aside from being able to withdraw your original contributions penalty and tax free at any time, there are exceptions to the 10% early withdrawal penalty rule.
I note this because I know emergencies come up and it’s important to understand ALL the information about an account and how it operates. But please remember the purpose of this account is to grow tax FREE for as long as possible. Try to remain mindful of that purpose!
Exceptions to the 10% Early Withdrawal Penalty:
- First Time Home Purchase: You use the withdrawal (up to a $10,000 lifetime maximum)
- Qualified Education Expenses
- Qualified Expenses Related to Birth or Adoption
- Disability or Death
- Unreimbursed Medical Expenses or Health Insurance if Unemployed
What If I Never Need to Withdraw the Money from the Account?
Luckily for you, you aren’t required to. You could let this money grow tax free for your entire life. Upon your passing you could use it as a generational wealth transfer tool to your family, friends or whoever you desire passing money down to.
Depending on your overall estate value when you pass, your Roth IRA may be able to pass to your beneficiaries tax free. Then upon their withdrawals, they would be able to withdraw tax free as well. I will save the estate planning thoughts for another post but at least this gets you thinking about it!!
How Do You Open a Roth IRA?
The account opening process would go a little something like this…
- Open a Roth IRA investment account at any brokerage firm of your choosing. (Fidelity, Vanguard, Merrill Edge, Charles Schwab, etc. to name a few)
- Contribute after tax dollars into the account.
- After tax dollars essentially means your money has already been taxed. Any amount of money contributed from your checking account has in theory already been taxed, whether through withholdings from your paycheck or will be taxed through your tax filing come tax time.
- Invest the money within the account and every dollar earned grows tax FREE.
- In future years, your withdrawals are tax free to be used at your discretion. (Of course, like anything tax related…given you follow a few guidelines as listed above).
The bottom line is I could argue that a Roth IRA makes sense for almost anyone who is both under the income limitations and who has earned income. If you are contemplating or questioning if this makes sense for you – let’s have a conversation!
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