What is a Roth IRA?
A Roth IRA (Individual Retirement Account) is a type of retirement savings account. Roth IRAs offer unique tax advantages. Unlike Traditional IRAs, your contributions to a Roth IRA are made with after-tax dollars, meaning you won't get a tax deduction for your contributions. However, the money in your Roth IRA grows tax-free, and qualified withdrawals in retirement are also tax-free.
Whether or not an individual is eligible to contribute to a Roth IRA is determined by the income level and tax filing status, described below.
How a Roth IRA Works
For the 2024 tax year, the contribution limit to all your IRAs (both traditional and Roth for a traditional IRA is $7,000 for individuals under the age of 50. If you are 50 or older, you can make an additional catch-up contribution of $1,000, bringing the total limit to $8,0001. These limits are subject to change, so it's important to stay updated on the latest contribution limits set by the IRS.
Eligibility to contribute to a Roth IRA is based upon an individual’s adjusted gross income (AGI) and their tax filing status.
- For single filers, the ability to contribute phases out between $146,000 and $161,000 of modified adjusted gross income (MAGI).
- For married couples filing jointly, the phase-out range is between $230,000 and $240,000.
Further details can be found here2.
Additionally, a traditional IRA can be established by transferring assets (“rolled over”) from an eligible retirement account, such as a 401(k) account3.
Tax benefits and withdrawals with a Roth IRA
A couple of primary benefits of a Roth IRA is the tax-free growth of your investments (your contributions have already been taxed) and withdrawal rules that are more flexible than traditional IRAs.
To make a qualified withdrawal, the account must have been open for at least five years, and you must be at least 59½ years old. Additionally, you can withdraw your contributions (but not earnings) at any time without penalty or taxes, which provides flexibility in case of emergencies.
Other scenarios may also qualify for a tax and penalty free distribution, as detailed here4.
Roth IRA - Required Minimum Distribution
Unlike traditional IRAs, Roth IRAs do not have required minimum distributions (RMDs) during the account holder's lifetime. This means you are not forced to withdraw money at a certain age, allowing your investments to continue growing tax-free for as long as you like. This feature makes Roth IRAs an excellent tool for estate planning, as you can leave the account to your heirs without them having to take RMDs during your lifetime.
Retirement Benefits
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How to invest the funds in a Roth IRA
You can invest the funds in your Roth IRA in a variety of assets, including stocks, bonds, mutual funds, ETFs, and more. The key is to choose investments that align with your risk tolerance, time horizon, and retirement goals. It's essential to diversify your investments to manage risk and maximize potential returns.
How to decide if a Roth IRA is right for you
Deciding whether a Roth IRA is right for you depends on several factors, including your current income, current tax bracket, expected tax bracket in retirement, and your financial goals. If you expect to be in a higher tax bracket in retirement, a Roth IRA may be advantageous because you pay taxes on your contributions now. Additionally, if you value the flexibility of tax-free withdrawals and the absence of RMDs, a Roth IRA could be an appropriate choice.
A Roth IRA is a powerful tool for retirement savings, offering the opportunity for tax-deferred growth over time and flexible distribution options. Remember to stay updated on any IRA rule changes regarding contribution limits and distribution options to maximize the benefits of your traditional IRA.
It's always a good idea to consult with a financial advisor to determine the best retirement strategy for your individual situation.
