Everything You Need to Know About Roth IRAs

When it comes to retirement planning, many people never look beyond their employer-sponsored 401(k) plan. And why not? Signing up is simple, there are very few decisions to make, and contributions are automatic.

But, while a 401(k) is a good, well-rounded plan, some retirement savers might want a different option or a secondary plan.

Roth IRAs offer tax advantages that help make them desirable to some retirement savers. But because employers do not typically offer them, they require shopping around on your own for a provider you trust. They also come with eligibility requirements that prevent some people from making contributions.

Because of the additional limits and required effort, learning more about Roth IRAs might be helpful before beginning to shop for a plan. To help, I’ve put together this guide to help you better understand how Roth IRAs work, their eligibility requirements, and how to tell if a Roth IRA is the right choice for you!

Types of IRAs

Several types of IRAs are available to individuals, each with its own rules and benefits. The most common are Traditional IRAs, Roth IRAs, and SIMPLE IRAs. Traditional IRAs offer tax-deductible contributions and tax-deferred growth, but withdrawals in retirement are taxed as ordinary income. SIMPLE IRAs are employer-sponsored retirement plans that allow employer and employee contributions, with the employee’s contributions being tax-deductible.

What is a Roth IRA and How Do They Work?

A Roth IRA is a popular Individual Retirement Account (IRA) type. Roth IRAs offer a few desirable benefits.

First, they offer tax-deferred growth. This means you won’t need to pay taxes on your account’s earnings, even when taking out qualified distributions. Qualified distributions must meet certain qualifications, such as the account holder being 59 1/2 or older or suffering an injury or illness resulting in a permanent disability.

Second, Roth IRA contributions are made with after-tax dollars. This means that, unlike a 401(k), Roth IRA contributions are not tax-deductible. However, because you’ve already paid income tax on these contributions, distributions made during retirement are not considered taxable income. As a result, you can take tax-free distributions.

Third, Roth IRAs are not subject to Required Minimum Distributions (RMDs). This differentiates them from other retirement benefit accounts, which require the account holder to withdraw a minimum amount once they reach a certain age.

Finally, Roth IRAs allow for catch-up contributions. Catch-up contributions offer a higher annual contribution limit for those nearing retirement age (ages 50 and up). For 2023, the contribution limit is $6,500 for those under 50. Those 50 and older can contribute an additional $1,000 for a total of $7,500. The contribution limits (including catch-up contributions) go up regularly, so staying current with the latest limits is important.

Eligibility for Roth IRAs

Roth IRAs have maximum income limits. Those who earn below these limits are eligible to make Roth IRA contributions. The limits are based on your filing status and modified adjusted gross income (MAGI). However, Roth IRAs don’t have a hard, singular earned income limit. Instead, they have “phase-out” ranges. This means that the more you earn, the less you can contribute to a Roth IRA. In other words, Roth IRA contribution limits “phase out” the closer your income gets to the top of the range.

For example, in 2023, the phase-out range for a single tax filer is $138,000 to $153,000. If a single tax filer earns less than $138,000, they can make the maximum contribution of $6,500. If they earn more than $138,000 but less than $153,000, they can still contribute to a Roth IRA. However, their contribution limit lowers (phases out) the closer their income gets to $153,000. If they earn more than $153,000, they can no longer contribute.

The Roth IRA phase-out limits for 2023 are:

• $138,000 to $153,000 (Single tax filers)
• $218,000 to $228,000 (Married, filing jointly)
• $0 to $10,000 (Married, filing separately, living together at any time in the tax year)

How can I tell if a Roth IRA is right for me?

Despite their tax advantages, Roth IRAs aren’t for everyone. Several factors can help determine whether a Roth IRA is the right choice for your retirement. A financial advisor can help you figure out if a Roth IRA can help you save enough for retirement.

Here are a few things to consider when contemplating whether a Roth IRA is right for you:

Tax Bracket

If you expect to be in a higher tax bracket when you retire than you are now, a Roth IRA might be a good choice for you. That’s because higher brackets come with higher tax rates. By paying the taxes now, while you’re in a lower bracket, you’ll pay less in taxes. Over decades, this can save you a lot of tax money and significantly reduce your lifetime tax burden.

Income

As stated above, maximum income limits exist for making Roth IRA contributions. If you earn more than the limit, you might prefer a traditional IRA or an employer-sponsored plan, such as a 401(k) or 403(b).

Time Horizon

One of the most appealing benefits of a Roth IRA is the tax-deferred growth. This can be a huge advantage if you have decades left before retirement. The longer your time horizon, the more lucrative that growth can be. If you’re closer to retirement, you might choose an option with higher contribution limits. That way, you can stash away larger amounts of money right before you retire.

Estate Planning

A Roth IRA is a good option to leave behind as an inheritance for your loved ones. This helps them avoid paying income tax on the distributions they receive, and naming them as retirement plan beneficiaries can also help them avoid estate taxes on their inheritance. This can be a significant advantage compared to other retirement accounts, which may result in a tax burden for your heirs.

Access to Funds

Roth IRAs offer more flexibility in accessing your funds before retirement than traditional IRAs. You can withdraw your contributions (but not earnings) from a Roth IRA at any time without taxes or penalties. While we don’t recommend making withdrawals before retirement, this can be useful in emergencies or for specific financial goals like buying a house or funding education expenses.

Continued Growth in Retirement

Roth IRAs are a good option if you plan on having multiple sources of retirement income. This is especially true if you can afford to live off those other sources of income. Because Roth IRAs don’t have RMDs, leaving them untouched means they can continue to grow throughout your retirement. Additionally, Roth IRAs let you continue to contribute after you reach age 70 1/2, should you choose to do so.

Converting a Traditional IRA to a Roth IRA

If you decide you’d like to convert your Traditional IRA into a Roth IRA, you can do so. It’s called a “Roth conversion” and is a relatively simple process. Once you’ve found a Roth IRA provider, let them know you’d like to convert your Traditional IRA to a Roth account. If both accounts are from the same provider, they should be able to do it fairly easily. If the accounts are with two separate providers, they’ll each ask you to provide some basic information, such as account numbers and amounts.

When you perform a Roth conversion, you’ll need to pay taxes on the amount you convert since your Traditional IRA contributions were made pre-tax.

Roth IRA vs. Workplace Retirement Plans

While Roth IRAs offer many advantages, they don’t work for everyone. If you’d prefer a plan with higher contribution limits, you might consider a plan offered by your workplace. Most employers offer 401(k) plans. However, some might offer a 403(b) or a SIMPLE IRA.

An employer match program is one of the primary benefits of a workplace retirement plan. Through such a program, your employer agrees to contribute to your plan. This is in addition to your own contributions and doesn’t typically count toward your contribution limit. This is essentially free money, and it can go a long way in helping you reach your retirement goals.