Table of Contents
- Roth IRA – One of the Best Retirement Tools
- Types of IRAs, and Why a Roth IRA Rules
- Roth IRA Eligibility Requirements
- 2022 Roth IRA Income Limits
- Roth IRA Contribution Limit Rules
- Roth IRA Distribution Rules
- Roth IRA Conversions
- Deductible and Non-Deductible Traditional IRAs
- Roth IRA Conversion Process
- Taking Advantage of Roth Conversions (Timing is Everything!)
- Who is Eligible for Roth IRA Conversions?
- Two Options for Converting Traditional IRAs into Roth IRAs
- Once You Go Roth, You Never Go back
Roth IRAs are among the best retirement investment vehicles. They allow investments to grow tax-exempt until retirement age and offer tax-free withdrawals.
You may have heard about a Roth IRA.
It’s one of those terms that gets bandied about on TV or the radio with great frequency. And with good reason because a Roth IRA is an investment account that is among the best ways to prepare for retirement.
Roth IRAs are tax-advantaged individual retirement accounts that offer varied investment opportunities and exceptional tax benefits.
Individuals can make contributions with after-tax dollars into an investment account where the contributions grow without the drag of taxes. They can be withdrawn tax-free in retirement at age 59 ½ or later.
You contribute to a Roth IRA with money you already paid taxes on. The money compounds tax-free, and you can make tax-free withdrawals in retirement.
To top it off, there are no required minimum distributions (RMDs), meaning you don’t need to make withdrawals.
This is advantageous when you reach retirement age. You can withdraw investments without paying additional taxes or defer withdrawals until you are ready.
Roth IRA – One of the Best Retirement Tools
Retirement planning is something everyone needs to do. Even if you serve in the military long enough to earn a retirement and pension, it might not be enough for your golden years.
It is essential for everyone to take retirement planning into their own hands, and retirement accounts such as the Thrift Savings Plan, 401(k) plans and IRAs are a great way to do that.
Types of IRAs, and Why a Roth IRA Rules
There are two types of IRAs available to most people – traditional IRAs and Roth IRAs. While similar, there are differences when it comes to paying taxes on contributions and withdrawals.
Here is a primer about traditional and Roth IRAs:
- Traditional IRA. Contributions are tax free if you meet income requirements, and withdrawals are taxed in retirement years. There are required minimum distributions once you reach age 72.
- Roth IRA. Contributions are made from already-taxed income, and withdrawals in retirement are tax free. There are no required minimum distributions.
Let’s break this down in simple terms.
With a traditional IRA, you can take a tax break on your income now, but you will have to pay taxes when you withdraw retirement funds. You must also take withdrawals from your account once you reach the required minimum distribution age, regardless of your income needs.
With a Roth IRA, you make contributions from income that was already taxed, making you eligible for tax-free withdrawals in retirement.
This is a great deal, especially if you are in a lower tax bracket than you anticipate being in retirement. It also takes the guesswork out of retirement planning, since you know the money in your account is not taxable.. Finally, you aren’t required to take distributions, so you can leave money in your account and continue to let it grow. (This can also be advantageous for estate planning.)
Roth IRA Eligibility Requirements
There are two main Roth IRA eligibility requirements:
- You must have earned income.
- You must meet income requirements.
The earned income must be taxable and can include wages and salaries, tips, bonuses and other compensation related to services you’ve provided. Income from interest, dividends or other investments does not qualify as earned income for Roth IRA purposes.There is also a special provision for military members. The Heroes Earned Retirement Opportunities (HERO) Act allows military members with tax-free combat pay to contribute to Roth IRAs and other retirement plans.
2022 Roth IRA Income Limits
There is a cap on how much you can earn and contribute to a Roth IRA.
For the 2022 tax year, Roth IRA eligibility begins phasing out at an annual modified adjusted gross income (MAGI) of $129,000 for single tax filers. Single tax filers are ineligible to make Roth IRA contributions when their income reaches $144,000. The limits are higher for married filing jointly, with eligibility phasing out starting at $204,000 and ending at $214,000.
The following table breaks down Roth IRA income limits:
|Filing Status||Modified AGI||Allowable Contribution|
|Married filing jointly or qualifying widow(er)||$204,000 or less||Up to the annual contribution limit|
|more than $208,000 but less than $214,000||Partial amount|
|$215,000 or more||No contribution|
|Married filing separately and you lived with your spouse at any time during the year||less than $10,000||Reduced amount|
|$10,000 or more||No contribution|
|Single, head of household or married filing separately and you did not live with your spouse at any time during the year||$129,000 or less||No contribution|
|more than $129,000 but less than $144,000||Partial contribution|
|$144,000 or more||No contribution|
What to Do if Your Income Exceeds Roth IRA Contribution Limits
The tax advantages for IRAs are generous. Because of that, the federal government limits them to people who fall within certain income brackets. If you don’t meet income requirements to get the tax benefits from the traditional IRA or contribute directly to a Roth IRA, you can still contribute to a non-deductible traditional IRA and convert it to Roth IRA at a later date. It’s kind of like a back door that enables just about anyone to contribute to a Roth IRA, regardless of their MAGI.
Roth IRA Contribution Limit Rules
The next thing to consider is how much you contribute to your Roth IRA.
If you meet income requirements, then you can contribute up to $6,000 if you are younger than age 50, or $7,000 if you are age 50 or older. (The additional $1,000 represents a catch-up contribution to help those closer to retirement better reach their investment goals.) Contribution limits for both Roth and traditional IRAs are the same.
It is important to note the limits apply for all IRAs opened during the specific tax year. Since you can open both traditional and Roth IRAs in the same year, be careful not to exceed contribution limits across both accounts.
The following chart shows IRA contribution limits for 2002-2022.
|Tax Year||Contribution Limit |
Age 49 or Younger
|Catch-Up Contribution |
Limit Age 50 or Older
Age 50 or Older
|2019 - 2022||$6,000||$1,000||$7,000|
|2013 - 2018||$5,500||$1,000||$6,500|
|2008 - 2012||$5,000||$1,000||$6,000|
|2006 - 2007||$4,000||$1,000||$5,000|
|2002 - 2004||$3,000||$500||$3,500|
Roth IRA Distribution Rules
Distributions are among the main benefits of using a Roth IRA instead of a traditional IRA. As previously mentioned, distributions from Roth IRAs are tax-free, whereas traditional IRA distributions are taxable.
Roth IRAs have an added benefit over traditional IRAs because there is no required minimum distribution age with a Roth IRA.
There are other rules and considerations to be aware of.
First, you can withdraw contributions at any time, tax-free and penalty-free. But that does not apply to earnings or interest on your contributions.
To avoid paying penalties on Roth IRA withdrawals for earnings or interest, you must wait at least five years from the date you contributed the funds, and you must be at least 59 ½ years old.
This is called the five-year rule.
Exceptions for early Roth IRA withdrawals. There are other Roth IRA withdrawal rules that may apply to your situation. For example, you may be able to make penalty-free withdrawals if you become disabled, want to purchase your first home or pay for qualified educational expenses. Read more about Roth IRA withdrawal rules or consult with a financial planner or tax professional before making any early Roth IRA withdrawals.
Early Roth IRA withdrawals not qualified under Internal Revenue Service (IRS) rules may be subject to a 10% early withdrawal penalty.
Roth IRA Conversions
Should you consider a Roth IRA Conversion?
Moving money held in a traditional IRA into a Roth IRA is called a Roth IRA conversion. Many people choose to do Roth IRA conversions because Roth IRAs have tax advantages over traditional IRAs. Roth IRA distributions are not taxable income. The lack of required minimum distributions also gives Roth investors more long-term flexibility.
Deductible and Non-Deductible Traditional IRAs
There are two types of conversions: conversions from deductible traditional IRAs and non-deductible traditional IRAs.
Deductible IRAs are those where you deducted the contribution on your taxes. Non-deductible IRAs are those without a corresponding tax deduction.
These are common for people whose income exceeded the traditional IRA and Roth IRA income limits.
Contributing to a non-deductible IRA still allows contributions to an IRA during the tax year. This is often used by people who want to do a back-door Roth IRA (contributing to a non-deductible IRA, then immediately converting it into a Roth IRA).
Roth IRA Conversion Process
During the conversion process, the money rolled over from a traditional IRA into a Roth IRA is added to your annual taxable income for that year. This is considered taxable income because you did not pay taxes on the contributions or their earnings. The IRS still needs to assess taxes on that income and gains. So you pay when you convert, and file your taxes the following year.
Non-deductible IRA conversions are not considered taxable income. So you do not pay taxes on the contribution amount. However, you pay taxes on any non-deductible IRA gains.
Many who take advantage of Roth IRA conversions using non-deductible IRAs convert the non-deductible IRA as soon as possible to avoid taxable gains. This is called a back-door Roth IRA.
Important note: The pro-rata rule. The IRS requires taxpayers who convert a traditional IRA to a Roth IRA to convert them on a pro-rata basis. That means you can’t just convert only non-deductible IRAs to a Roth IRA if you also have deductible IRAs. You must convert them proportionally. This is done so the IRS receives taxes at the time of conversion. This is an advanced matter, and one worth investigating with a tax professional or fee-only financial planner.
- Roth IRA conversion timing (part one)
- How to optimize Roth conversions: Why timing is important (part two)
- Roth conversion for your TSP account – five tax-planning considerations
Taking Advantage of Roth Conversions (Timing is Everything!)
When you pay taxes on the money you roll over, you pay taxes on the current value of the money. That makes it possible to take advantage of economic downturns or your current tax bracket.
Future distributions from newly created Roth IRAs are the same as any other Roth IRA; those are non-taxable.
Investors currently in a low tax bracket often decide to invest using Roth IRAs because they expect to be in a higher tax bracket when they retire. This is common for those who have recently retired or are between jobs.
Paying taxes on money in a lower tax bracket saves overpaying taxes later in a higher bracket.
Many convert a traditional IRA into a Roth IRA when the economy is struggling because their traditional IRA has less value, resulting in a lower taxable amount.
Who is Eligible for Roth IRA Conversions?
You must meet eligibility requirements for converting a traditional IRA into a Roth IRA:
- You cannot convert a traditional IRA if you inherited it from someone other than a spouse.
- You can convert traditional IRAs to Roth IRAs even if you have made a rollover within the same year.
- You can convert a portion of the traditional IRA into a Roth IRA, but not just the non-taxable part.
Two Options for Converting Traditional IRAs into Roth IRAs
There are two ways to move money from a traditional IRA into a Roth IRA.
- You can convert the funds yourself by taking a distribution from the traditional IRA and rolling it into a Roth IRA within 60 days.
- You can contact the bank or broker who manages your traditional IRA and instruct them to transfer the money into a Roth IRA for you.
Most investment firms are happy to initiate and process the Roth conversion or rollover for you. This is typically the easiest and safest method, since you avoid potential mistakes or penalties.
For example, if you cash out your IRA without rolling the IRA funds into your new IRA within 60 days, it is treated as a withdrawal instead of a conversion. Also, you would owe taxes on the full amount plus penalties if you are younger than age 59 ½.
Whether you choose to roll over or transfer funds, it’s necessary to use the entire traditional IRA distribution amount to fund the Roth IRA to avoid early withdrawal penalties and fees. You can not keep some money as cash or to take a vacation.
Once You Go Roth, You Never Go back
The prospect of having a tax-free nest egg in retirement is very attractive, and something you won’t want to pass up. There aren’t many opportunities for tax-free income, especially when it comes to investments. The longer you have before retirement age, the more time you have for compound interest to increase your nest egg. If you are eligible, consider a Roth IRA, and max out your contributions each year.
Take action! If you are interested in opening a Roth IRA, then check out this list of recommended places.