Roth IRA accounts are the common individual retirement accounts. Contributions are made after tax deductions, and then grow without incurring taxes. Withdrawals during retirement are also tax-free, making the account an excellent source of retirement income. In contrast, contributions to traditional IRA accounts provide a tax deduction, reducing your tax bill now but requiring taxes to be paid upon withdrawal of funds during retirement.
Tax-Free Growth with a Roth IRA
The biggest benefit of a Roth IRA is that the money in the account can grow entirely tax-free. You do not pay taxes on any activity within the account. There are no taxes on any capital gains or dividends you may receive from your investments.
Tax-Free Withdrawals from a Roth IRA
What sets Roth IRA accounts apart from traditional Roth IRAs and other retirement accounts is that withdrawals you make from the account are tax-free. You pay taxes on the money before you contribute it to a Roth IRA, so you do not have to pay taxes on principal or earnings when withdrawing funds.
Greater Flexibility for Early Withdrawals
You will enjoy tax incentives that help you build your savings when you contribute to a retirement account, but you will also face restrictions on how you can use the money you contributed.
Typically, you must wait until age 59 and a half before withdrawing money from a traditional Roth IRA or a 401(k). Most withdrawals made before reaching this age incur a 10% penalty plus the taxes you owe, although there are some exceptions.
You can withdraw the money you contributed to a Roth IRA at any time without paying taxes or penalties.
You can start withdrawing earnings from a Roth IRA after reaching age 59 and a half, as long as the account has been open for at least five years. There are certain scenarios in which you can avoid taxes or penalties, or both, on early withdrawals from a Roth IRA if you are younger than 59 and a half, even if the account has not been open for a full five years. For example, penalty-free withdrawals may be allowed to pay for first-time home purchase costs, qualified educational expenses, or medical expenses.
A Roth IRA Allows You to Avoid RMDs
Account holders must begin making required minimum distributions (RMDs) from traditional Roth accounts or 401(k) accounts starting the year after they turn 72. The amount of these withdrawals varies according to the age of the account holder and the amount of money in their IRA or 401(k).
The need to make these withdrawals can make tax planning more complicated because you have less control over when and how much money you withdraw from the account. Since withdrawals from traditional retirement accounts are considered income, taking a large withdrawal in a given year can mean paying a lot in taxes.
Roth IRA accounts have no RMD requirements as long as the account holder is alive, giving you more control over how and when you use the money in the account.
Should You Open a Roth IRA?
A Roth IRA is a good option for many savers, but it works best in some situations than others.
When a Roth IRA Works Best:
Investors pay taxes on the money before they contribute it to a Roth IRA, and then they do not pay taxes on withdrawals. Roth IRA accounts provide a tax exemption upfront in exchange for paying taxes on withdrawals during retirement.
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A Roth IRA account may be a good option for younger savers with lower income who fall into a lower tax bracket. Choosing a Roth IRA will reduce the total amount of taxes they will pay if they expect to be in a higher tax bracket later in life.
Who might prefer a traditional Roth account:
A traditional Roth account provides a tax incentive upfront, so individuals with higher incomes can save money by contributing to this type of account. If you expect to be in a lower tax bracket during retirement than you were when making contributions, it’s usually best to use a traditional Roth account.
Roth IRA Limitations
One thing to keep in mind is that there are limitations on who can contribute to a Roth IRA.
The basic rule depends on your income. You must stay below a certain income level to contribute to a Roth account. The amount you can contribute begins to decrease until it reaches 0 if your income exceeds the maximum based on your tax filing status.
Here are the income limits for 2022:
Income limits for 2022:
- Married filing separately or head of household: Less than $129,000 – Between $129,000 and $144,000 – $144,000 or more
- Married filing jointly: Less than $204,000 – Between $204,000 and $214,000 – $214,000 or more
If you are married and filing separately, your income limits depend on whether you lived with your spouse for any part of the year.
The federal government typically increases these limits annually to keep up with inflation. They will increase in 2023.
Income limits for 2023:
- Married filing separately or head of household: Less than $138,000 – Between $138,000 and $153,000 – $153,000 or more
- Married filing jointly: Less than $218,000 – Between $218,000 and $228,000 – $228,000 or more
Note: The maximum contribution limit for a Roth IRA for 2022 is $6,000, which will increase to $6,500 in 2023. An additional contribution of $1,000 is allowed if you are age 50 or older. There may be additional restrictions on the amount you can contribute based on your income.
Conclusion
Roth IRA accounts are one of the best ways to save for retirement, especially if you are in a low tax bracket. The opportunity for your investment to grow without paying taxes for decades can help you avoid paying thousands of dollars in taxes that you would otherwise have to pay.
But remember that a traditional Roth account may be a better option for some individuals. Consider speaking with a financial advisor if you are unsure which retirement account is best for you.
Frequently Asked Questions (FAQs)
How can I open a Roth IRA?
You can open a Roth IRA through most brokerage firms. It’s best to keep a Roth IRA at the same broker you use for your brokerage account, if you have one. This can make it easier to deposit funds and manage your portfolio.
How much money can you put into a Roth IRA?
You can contribute a maximum of $6,000 annually to Roth IRA accounts, which will increase to $6,500 in 2023. You can contribute the full amount to a Roth IRA or a traditional retirement account, or you can split these funds between the two types of accounts. You can contribute an additional $1,000 annually if you are age 50 or older. There may be additional restrictions on the amount you can contribute based on your income.
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Source: https://www.thebalancemoney.com/top-benefits-of-roth-ira-5225891
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