What is a Roth IRA? It’s a qualified individual retirement account that provides tax advantages that enable your investment to grow tax-free. If you’re saving for retirement, you might want to consider opening one.
With a Roth IRA, you make contributions with money that has already been taxed, so when it comes time for you to retire, your distributions are entirely tax-free. IRS rules, however, govern the maximum amount you can contribute to your Roth IRA and how you can make withdrawals when you’re ready to retire.
Roth IRA Rules
Roth IRAs differ from other qualified retirement plans in a number of ways. To make an informed retirement planning decision, be aware of certain restrictions imposed by IRS regulations. Here are the details on Roth IRA contribution and distribution tax implications:
- You contribute money that you’ve already paid taxes on, like money from your paycheck, so your money grows tax-free.
- Unlike 401ks, you cannot deduct your contributions on your federal income tax.
- Once you turn 59.5 and you have had your account for at least five years, your withdrawals will be tax-free.
Related: Save for Retirement with an IRA
Income Eligibility Test for Roth IRAs
You must not exceed the Roth IRA income limits established by the IRS, which are based on your adjusted gross income. For 2017, requirements for single filers and married couples are:
- You must make less than $196,000 per year if you file as a qualifying widower or married filing jointly.
- You must make less than $133,000 if you file as single, head of household, or married filing separately — and you did not live with your spouse at any time during the year.
Roth IRA Contribution Limits
One big difference between a Roth IRA and other retirement plans is the maximum amount you are allowed to contribute per year. For 2017, Roth IRA limits are $5,500 or $6,500 if you are 50 or older. Certain exceptions might apply based on your tax filing status and adjusted gross income.
Roth IRA Distribution Rules
The required minimum distribution rule requires 401k or traditional IRA account holders to take distributions from their qualified retirement plans once they reach 70.5. Roth IRAs, however, are exempt from this rule. You can continue to make contributions to your Roth IRA indefinitely and there are no mandatory distribution requirements.
Find Out: How to Convert Your 401k to a Roth IRA
Roth IRA Early Withdrawal Penalties
Unless an exception applies, any distributions you take from a 401k or traditional IRA before you’re 59.5 are subject to a 10 percent early withdrawal tax. If you’ve had your Roth IRA for five years and you meet one of the following qualifications, you — or an heir — can access the funds penalty- and tax-free:
- You die and the funds revert to a beneficiary of your estate.
- You are disabled.
- You qualify for a first-time home purchase.
Comparing Retirement Savings Plans
The main distinction between a traditional IRA and Roth IRA is the method by which taxes are levied. You make contributions to a traditional IRA with pre-tax dollars and you can deduct your contributions on your federal income tax. Once you start taking distributions, however, you will be taxed at your current tax bracket. Your contributions to a Roth IRA are after taxes and you cannot deduct them.
A 401k differs from a Roth IRA in that it is an employer-sponsored retirement plan. The two plans also differ in their maximum allowable contribution amounts — you can contribute significantly more to a 401k than a Roth IRA. You might want to use a Roth IRA to supplement your existing 401k. Consult this chart that shows the higher contribution amounts allowable with a 401k:
|Maximum Retirement Account Contributions|
|Roth IRA||401k||Roth 401k|
|Maximum Contribution Age 49 and Under||$5,500||18,000||18,000|
|Maximum Contribution Age 50 and Older||$6,500||24,000||24,000|
You can open a Roth IRA at any bank and at most other financial institutions, like investment brokerage firms. Some firms might require an initial minimum opening deposit to fund your account, and some might not. Do your research to find the best place to open your Roth IRA.