6 Roth IRA Rules You Need to Know

Know these Roth IRA rules and limits so you can save more money for retirement.

Roth individual retirement accounts have tax rules you should be aware of, especially regarding Roth individual retirement account eligibility, contributions and withdrawals. Knowing these Roth IRA rules can help reduce what you pay in taxes and grow your retirement savings.

What Is a Roth IRA?

A Roth IRA is a type of individual retirement account that allows you to save for your retirement without having to pay taxes every year on your earnings like you would in a regular investment account. The main benefit of a Roth IRA is that your earnings grow tax-free. That means that if you sell a stock at a profit in your account, you don’t have to pay taxes on your gain. Similarly, if you earn interest or dividends in the account, you don’t have to include that in your income. The money is simply paid into your account, without any taxes being due.

See: Best Roth IRA Providers 2019-2020

Important Roth IRA Rules to Know

Before you commit to saving and investing with a Roth IRA, understand exactly what’s involved so you can decide if it’s right for your financial strategy. Here are six Roth IRA rules you should know:

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1. Roth IRA Withdrawals Are Tax-Free

Here’s an answer for the question, “Can I withdraw money from my IRA?” Under certain circumstances, you can make a penalty-free withdrawal from your IRA, but IRA rules vary depending on which kind of individual retirement account you have. Qualified distributions from Roth IRAs are completely tax-free. For example, if you contribute $50,000 to your Roth over your lifetime and it grows to $110,000 by your retirement, the entire $110,000 can be withdrawn tax-free, including the $60,000 in earnings. Typically, withdrawals from a traditional IRA prior to age 59.5 will face a 10 percent penalty in addition to state and federal taxes.

Additionally, unlike traditional IRAs, which require mandatory distributions after you reach age 70.5, you never have to take any money out of your Roth IRA if you don’t want to.

Related: How to Use Your IRA as a Last-Minute Tax Deduction

2. Roth IRA Contributions Are Funded With After-Tax Money

Unlike a traditional IRA, for which you can typically reduce your taxable income and thereby fund the account with pretax contributions, Roth IRA contributions are funded with after-tax money. Roth contributions can come from your checking or savings account or directly from your paycheck, but only after you’ve paid tax on it.

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You can keep contributing to a Roth even after you turn 70.5, which you can’t do with traditional IRAs. You can make rollover contributions to a Roth or traditional IRA regardless of your age; however, no matter when you make your contribution, you’ll have to observe Roth IRA contribution limits.

3. The Roth IRA Contribution Limit for 2017 Is $5,500

If possible, you should try to hit the maximum contribution limit for your Roth IRA. The maximum amount you can contribute to a Roth IRA is subject to annual adjustment from the IRS; for 2017, the Roth IRA maximum contribution amount is $5,500. The limit jumps to $6,500 if you are age 50 or older; however, you can only contribute earned income, such as your wages or salary. If you earn less than $5,500 — or $6,500 if you’re 50 years of age or older — your maximum contribution equals your taxable compensation for the year. Your contribution might also be income restricted, as there are income limits to Roth IRA contributions.

4.  Contribution Limits Vary Based on Your Income

Your Roth IRA contribution can be limited based on a combination of your tax filing status and your modified adjusted gross income. For example, if you’re married filing jointly and your MAGI exceeds $196,000, you cannot make a Roth IRA contribution. For amounts between $186,000 and $196,000, the IRS provides a calculation to determine the amount of your allowable contribution. Use this table for Roth IRA income limits for 2017 to determine your contribution limits:

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How to Determine Your Roth IRA Contribution Limit
If Your Filing Status Is … And Your Modified AGI Is … Then You Can Contribute 
Married filing jointly or qualifying widower Less than $186,000 Up to the limit
$186,000 up to $196,000 A reduced amount
$196,000 and over Zero
Married filing separately and you lived with your spouse at any time during the year Less than $10,000 A reduced amount
$10,000 and over Zero
Single, head of household or married filing separately and you did not live with your spouse at any time during the year Less than $118,000 Up the limit
$118,000 up to $133,000 A reduced amount
$133,000 and over Zero

5. Roth IRA Distributions Must Meet Certain Requirements to Be Deemed Qualified

A qualified distribution is any payment or distribution from your Roth IRA that meets requirements outlined by the IRS. A qualified distribution is defined by the IRS as follows:

  • Made five or more years after you first contributed to a Roth
  • Made on or after reaching age 59.5
  • Made because you’re disabled
  • Made to a beneficiary or an estate after your death
  • Made to put toward the purchase of a first home — up to $10,000

Even if your distribution isn’t qualified, you can always withdraw your contributions tax-free. You’ll face a 10 percent penalty if the account is less than 5 years old, but otherwise, you can take your contributions back at any age.

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6. A Backdoor Roth IRA Is a Workaround for Limits

If Roth IRA limits prevent you from contributing to a Roth IRA in the traditional way, there’s a method known as the backdoor Roth IRA that could allow you to open one. If your MAGI is too high to make a Roth contribution, you can make a non-deductible contribution to a traditional IRA, and then convert that amount to a Roth. If you make the conversion before your Roth assets appreciate, the conversion will be tax-free. One caveat: If you have other pre-tax accounts, such as a traditional IRA, a portion of your Roth conversion might be taxable.

Up Next: Roth IRA vs. Traditional IRA — Which Retirement Plan Is Better for You?

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About the Author

John Csiszar

After earning a B.A. in English with a Specialization in Business from UCLA, John Csiszar worked in the financial services industry as a registered representative for 18 years. Along the way, Csiszar earned both Certified Financial Planner and Registered Investment Adviser designations, in addition to being licensed as a life agent, while working for both a major Wall Street wirehouse and for his own investment advisory firm. During his time as an advisor, Csiszar managed over $100 million in client assets while providing individualized investment plans for hundreds of clients.

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6 Roth IRA Rules You Need to Know
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