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Utilizing a Roth IRA is one of the best ways to save and invest for your retirement. However, the appropriate use of one is often misunderstood. There are many benefits to using a Roth IRA that other accounts don’t offer. If you’re asking yourself, “What’s a Roth IRA?” here’s what you need to know.

Roth IRA vs. Traditional IRA/401(k)

The big difference between a Roth IRA and a traditional IRA is how it’s taxed. A traditional IRA or 401(k) is a retirement savings account that allows account holders to save for retirement with pretax dollars. For example, if you take home a $1,000 paycheck and contribute $100 to your 401(k), $100 will go into your account, and the remaining $900 is taxable. You’re lowering your income, therefore lowering the amount you’re taxed.

Once an account holder reaches retirement, withdrawals are taxed at the highest ordinary income rate. If the account holder chooses to take distributions before they reach 59 1/2, they will also have to pay a 10% penalty on the money withdrawn.

With a Roth IRA your contributions are not tax deductible, meaning you contribute to your account with after-tax dollars. Unlike traditional IRAs, Roth IRA withdrawals are tax free as long as you are under 59 1/2 or only taking out your contributions.

Think of a Roth IRA as a valuable tax break made at the back end, rather than the front end, explains Forbes contributor Ashlea Ebeling. Since your income will likely be higher by retirement, your tax rate will also be higher, yet your Roth IRA withdrawal will be tax free.

Eligibility Requirements

Before you get too excited about this tax-advantaged account, you need to determine if you’re eligible to contribute. If your filing status is single, head of household, or married and filing separately, you must make less than $122,000 to contribute the full amount. If you make less than $137,000 you can contribute a reduced amount. If you’re married and filing jointly or as a qualifying widow(er), you must make less than $193,000 to contribute the full amount and less than $203,000 to contribute the reduced amount.

With the 2017 average median average income being $61,372, most Americans qualify.

Contribution Limits

For 2019, taxpayers can contribute up to $6,000 annually in their traditional IRA and Roth accounts. This amount is up from the $5,500 contribution limit for the past few years. If you’re 50 or older, you can also contribute an additional makeup contribution of $1,000 per year, yielding a total contribution of $7,000 per year.

Flexible Retirement Savings

In addition to tax-free withdrawals in retirement, Roth IRAs allow you to withdraw your contributions at any time with no penalties. This gives you the flexibility to distribute funds in the case of a financial emergency.

In order to avoid taxes and penalties, you must hold your Roth account for five years and be 59 1/2 in order to tap into your earnings. There are some exceptions including death, disability or using $10,000 for a down payment on your first home purchase. Additionally, you can avoid income taxes but must pay the 10% penalty if you use funds from your account to pay for higher education expenses.

No Required Minimum Distributions

Since the IRS allows taxpayers to contribute to traditional IRA accounts with pretax dollars, they are eager to get their share when it comes time for retirement. That’s why the IRS mandates traditional IRA or 401(k) account holders to take Required Minimum Distributions (RMDs) after they turn 70 1/2 or retire. Even if you don’t need the money in retirement, you must take distributions.

With Roth IRAs, there are no required distributions. You can allow your money to grow as long as you prefer. This gives you the freedom and flexibility to use your Roth IRA dollars any way you choose. This is particularly useful for estate planning purposes, because it allows your account to continue to grow. Your heirs will not have to pay income taxes on inherited Roth accounts, but they will have to take distributions.

For other qualified distributions, you can visit IRS.gov for details.

Continued Savings Throughout Retirement

If you choose to work into your retirement years, you can continue to contribute to your Roth IRA. With traditional IRA accounts, you must stop contributing once you reach 70 1/2. You’re then required to begin taking RMDs. In the circumstance that you don’t have a company-sponsored retirement plan, your only option for savings with tax advantages is contributing to a Roth IRA.

Otherwise, you may need to place your savings in a taxable account.

Roth IRA Accounts Pair Well with Other Tax-Advantaged Accounts

If you have multiple retirement accounts, including a 401(k), a traditional IRA and a Roth IRA, you’ll have flexibility when retirement rolls around. For example, if you need money in retirement, you can withdraw funds from your traditional 401(k) or IRA up to the lowest tax bracket. If that is not enough to cover your retirement expenses, you can take the remaining amount from your Roth IRA tax free.

If you’re in a higher tax bracket, you can use your Roth distributions first to minimize any additional tax burden. Your Roth distributions can help offset the potential taxes you would incur if you invested 100% in a traditional IRA or 401(k).

Flexible Contribution Deadline

If you don’t reach the maximum Roth IRA contribution amount by December 31, don’t fret. You have until April 15 the following year to max out your Roth IRA contribution. The IRS gives you an extra few months to contribute to this tax-advantaged account.

If your budget was tight the previous year, you’re given a little extra time to fund your account. For example, if you only contributed $2,000 to your account in 2018, you will have until April 15, 2019, to contribute the remaining $4,000.

The Bottom Line

What’s a Roth IRA? It’s a tax-advantaged retirement savings account that provides many financial benefits for account holders. If you don’t have your own Roth IRA, it may be time to consider opening one. You can visit your local financial institution or online bank to get started.

Do you use a Roth IRA to save for retirement? If not, what’s holding you back? We want to hear from you! Leave your answers in the comments below.

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This Post Has 3 Comments

  1. Hello, would you mind if I printed multiple copies of this article for a jail program I volunteer with? The inmates had questions about 401Ks, investments, insurance, etc. Your article is nicely written in plain English. Thank you so much

  2. The statement, “One of the main advantages of a Roth IRA is that withdrawals are tax-free, without penalty, and can be done at any time.” is misleading (paragraph #3, sentence #2). It is true only if the withdrawals are done for specifically allowed reasons; allowed withdrawal amounts can also be limited, even for allowed reasons; and it is true only if no earnings are withdrawn, only contributions.

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