The ability to contribute to Roth IRAs can represent one of the most beneficial financial planning decisions that people can make for their future. Roth IRAs were established by the Taxpayer Relief Act of 1997 and while most people are aware of the name, they may not be fully aware of all of the benefits.
A Roth IRA is an individual retirement account that allows an individual to save for retirement in a tax-free vehicle. The table below illustrates the basic difference between Roth IRAs and other types of accounts. Here is a recap of the key features of a Roth IRA:
- Contributions are not tax deductible, but distributions are tax-free.
- Investment earnings are tax exempt.
- There are no required minimum distribution (RMD) requirements, allowing these accounts to grow tax-free indefinitely.
- Roth contributions can be made by any taxpayer with earned income even if they’re above the age of 70 ½.
- A distribution of your original Roth contributions (not investment earnings) can be made prior to the age of 59 ½ without penalty. For example, over the years a taxpayer contributes a total of $10,000 to a Roth IRA and then decides to take a distribution of $5,000. No taxes or penalties would be assessed on this distribution, even for someone under the age of 59 ½.
So who can contribute to Roth IRAs? Any taxpayer with earned income is eligible to contribute, regardless of age. As long as the taxpayer’s adjusted gross income is below phase-out limits of $186,000 to $196,000 ($118,000 – $133,000 Single filers), then a person can contribute up to $5,500 each year ($6,500 for those over 50). Given the unique characteristics of Roth IRAs, here are a few ideas and considerations that may be appropriate given your financial planning objectives:
- Roth IRAs can be a key component of both retirement and education savings strategies.
- Parents or grandparents can make Roth contributions for their children/grandchildren in years when the child has earned income.
- Converting existing traditional IRAs into Roth IRAs can be an appropriate strategy for people who have more itemized deductions than income. This could be a one-time or an ongoing strategy, depending on the circumstances.
- Roth IRAs can ultimately provide tax flexibility for those taking distributions during retirement.
- Naming grandchildren as the beneficiary of a Roth IRA could be a great idea. Doing so, will provide them with a tax-free asset that could last their entire lifetime.
We believe that Roth IRAs should be a key component of a long term savings strategy. If you have any questions, or would like to discuss how Roth IRAs might fit into your overall retirement and savings plan, please feel free to contact our office today.
|Personal Account||Deductible IRA/401(k)||Roth IRA|
|After-Tax Contributions||Pre-Tax Contributions||After-Tax Contributions|
|Taxed Annually on Income||Tax-Free Growth||Tax-Free Growth|
|Pay Capital Gains when sold or withdrawn||Pay Taxes when withdrawn||No taxes on withdrawals|