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The Benefits of a Roth IRA

August 25th, 2016

The traditional Roth IRA still remains a very viable choice for those who want to maximize their investment options , tax savings , and retirement planning. Following are some facts about the Roth IR A that may help you with your choice of retirement vehicle:

  1. There’s an annual contribution limit: You cannot throw your entire life savings into a Roth IRA. In 2016, the maximum contribution limit for Americans is $5,500 with earned income. This is a dynamic number set by the Internal Revenue Service that tends to change with the rate of inflation every couple of years.
  2. But you can contribute more if you’re older: However, if you’re age 50 or older; you are entitled to what is known as a “catch-up” contribution. The catch- up amount has been consistent at $1,000, meaning those with earned income after the age of 50 can contribute up to $6,500 in 2016.
  3. No age limits: Unlike the traditional IRA, which disallows regular contributions starting the year you turn 70112, Roth IRAs have no age limit when it comes to regular contributions. With Americans regularly living into their 80s, 90s and 100s, a Roth IRA is a tool that allows for ongoing contributions.
  4. Income limits could prevent your contribution to a Roth IRA: You should also understand that not everyone will be able to open, or contribute to, a Roth IRA as it is based on their modified adjusted gross income. In 2016, single filers’ Roth contributions could be limited if their adjusted income falls between $117,000 and $131,999. Adjusted income of $132,000 or above makes single filers ineligible for a Roth IRA contribution. For joint filers the phase out begins at $184,000, with couples becoming ineligible at $194,000 of adjusted income. Contact us before setting up a monthly contribution to a Roth IRA to determine if your income falls within the allowable limits.
  5. But there is a way around income limits: The good news is Roth IRA income limits don’t have to stop you, but they may slow you down a bit. Anyone, regardless of income, can open and contribute to a traditional IRA. Subsequently, a traditional IRA can be rolled over into a Roth IRA, since there are no income limits on converting your traditional IRA to a Roth IRA. What you need to keep in mind is that you can only roll over money from one IRA to another once within a 12-month period, thanks to new regulations implemented in 2015. If the funds contributed to the traditional IRA were pre-tax, then there will be a tax imposed when the funds are converted to a Roth, however no penalties will apply.
  6. Your eligible withdrawal age: Regardless of whether you invest in a Roth IRA or traditional IRA, the age at which you become eligible to begin taking regular withdrawals is 59.5 . But as you’ll see below, with a Roth IRA certain types of early, penalty-free withdrawals may be possible. (There are also specific situations that a traditional IRA withdrawal may also be penalty-free.)
  7. Tax-free in, tax-free out: With a traditional IRA, an early withdrawal before age 59.5 will likely be met with a 10% penalty on top of ordinary income tax. This makes sense given that traditional IRA contribution are in pre-tax dollars. With a Roth IRA, account holders can pull out what they ‘ve contributed to a Roth IRA at any time without tax or penalty (not including investment gains) since the money contributed is after-tax income. These contributions would probably be best left alone over time, but in a pinch they could be used for a mortgage or college tuition payment.
  8. The five-year rule: However, when it comes to earnings and interest generated within a Roth IRA, account holders are required to wait five years before making a withdrawal . Failing to follow the five-year rule could make your distribution unqualified and expose your withdrawal to federal taxes. This five-year rule applies to contributions, as well as conversions. The five-year rule for regular contributions to a Roth starts January 1st of the first year of contributions. The five-year rule for conversions is based on when the conversion occurred. Separate records must be kept to accurately determine when the five-year period has run.
  9. Minimum withdrawals are not required: One of the more beneficial aspects of a Roth IRA is that minimum distributions are not required. If you choose, you can let your Roth IRA grow without making a single withdrawal. Combined with no age limit for contributions, it’s easy to see why Roth IRAs can be such a powerful retirement tool. By comparison, a traditional IRA does require a minimum distribution beginning the year in which you turn 70.5.
  10. You could save a lot on your taxes in your golden years: Of course the best thing about a Roth IRA is that if you follow the rules, none of your distributions beginning at age 59.5 or after are taxable. If you begin contributing to a Roth IRA early in your working career, you could wind up saving hundreds of thousands of dollars thanks to time and compounding.
  11. Contributions can be made retroactively for tax purposes: Lastly, contributions to a Roth IRA (as well as a traditional IRA) can be made up until the due date of the tax return (usually April 15).

A Roth IRA can also be an effective planning tool if you own your own business and employ your children. While there are no age requirements for distributions from your Roth IRA, there is also no age requirement for setting up a Roth IRA. Since they will have earned income, the full amount can be contributed to a Roth IRA. Just remember to follow all the rules on employing your children and that they are a bona fide employee of your business.

 

 

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