In 1998, the Taxpayer Relief Act was passed by Congress to create the Roth IRA. It got its name from Senator William Roth who sponsored the legislation. A Roth IRA is an individual retirement account, a type of qualified retirement plan that’s funded with after-tax dollars so therefore the contributions being made are not tax deductible. However, when it comes time to begin withdrawing from your Roth IRA, all qualified distributions will be tax-free. So, as Roth IRAs turned 20 in January, let’s celebrate! But, before we do, we must first check and see if Roth’s make sense for you.
One way to look at a Roth IRA is as your personal “tax insurance.” This is because once you contribute to your account, the money is protected against future tax hikes. If you follow the rules properly, then you can look forward to completely tax-free distributions when you retire. According to Investment Company Institute, approximately 24.9 million American households had a Roth IRA in 2017. For 2018, the maximum contribution is $5,500 for those under age 50, and $6,500 for those age 50 and older. However, there are income limits for contributions and your ability to contribute will be impacted when your income exceeds $120,000 or $189,000 if married and filing jointly. For those high income earners out there, a backdoor Roth IRA conversion may be an appropriate strategy for you to consider.
A backdoor Roth IRA is when you convert Traditional IRA assets into a Roth IRA, which helps you to get around the income limits previously stated because there are no income limits for conversions. You can do a backdoor Roth IRA in one of two ways: First, contribute money to an existing Traditional IRA, sell shares, and then roll over the money to a Roth IRA account. Second, convert an entire Traditional IRA account to a Roth IRA account. Another benefit of this strategy is that you can roll over as much money as you want. However, it’s important to remember that you still will need to pay taxes on any money in your Traditional IRA that hasn’t already been taxed. Once you convert your funds into a Roth IRA, they will most likely be counted as income, which could then bump you into a higher tax bracket in the year you make the conversion.
Roth IRA’s can be a tremendous tool in making more of your money spendable. Although you typically must have held the account for a minimum of 5 years and be at least age 59½ before withdrawing tax and penalty free, there are a few exceptions. And, while you’re still living, they are never subject to required minimum distributions (RMDs). Once you pass, your Roth IRA beneficiaries must however take the RMDs, but your heirs will not have to pay income taxes on the inherited Roth IRAs.
If you want to learn more about Roth IRAs and how they can potentially help you achieve your goals for retirement, then CLICK HEREto request your complimentary, no obligation financial review. We’ll look at where you are compared to where you want to be in retirement, and help to incorporate your goals into a personalized and comprehensive financial plan.