Roth Individual Retirement Accounts (IRAs) are a good choice if you’re seeking tax-free withdrawals in retirement, want to avoid required minimum distributions (RMDs) beginning at age 70 1/2, or feel you’ll be in the same or a higher tax bracket in retirement. Roth IRAs offer you an opportunity to create tax-free income during retirement.
- Offers tax-advantaged growth potential
- Qualified distributions are tax- and penalty-free. Distributions are qualified after a five year holding period and you are age 59 1/2, or as a result of your death, disability, or if using the qualified first time homebuyer exception.
- The ability to withdraw your contributions at any time, without tax or penalty, if you need the money.
- No RMDs at age 70 1/2
Things to consider
- Your Modified Adjusted Gross Income (MAGI) determines your eligibility to contribute.
- You’re not able to deduct your contributions on your taxes, as they’re made with after-tax savings.
- Non-qualified distributions may be taxed and you may owe the 10% IRS tax penalty (some exceptions apply).
A Roth IRA conversion occurs when you take savings from a Traditional, SEP or SIMPLE IRA or employer-sponsored retirement plan such as a 401(k) and move them to a Roth IRA. At the time of conversion, you will pay the appropriate taxes due on before-tax dollars converted; the 10% IRS tax penalty does not apply. The benefits of tax-free income in retirement may justify the conversion. Be sure to talk to your tax advisor to discuss your specific situation before you decide to convert.
Individuals at any age with earned income, and their non‑working spouse, if filing a joint tax return are eligible to contribute to a Roth IRA as long as their Modified Adjusted Gross Income (MAGI) meets the following limits:
- During the 2016 tax year your Roth IRA contribution is phased out based on MAGI:
- Full contribution if MAGI is less than $117,000 (single) or $184,000 (joint)
- Partial contribution if MAGI is between $117,000 and $132,000 (single) or $184,000 and $194,000 (joint)
- No contribution if MAGI is over $132,000 (single) or $194,000 (joint)
- During the 2017 tax year your Roth IRA contribution is phased out based on MAGI:
- Full contribution if MAGI is less than $118,000 (single) or $186,000 (joint)
- Partial contribution if MAGI is between $118,000 and $133,000 (single) or $186,000 and $196,000 (joint)
- No contribution if MAGI is over $118,000 (single) or $196,000 (joint)
Individuals under age 50 can contribute up to $5,500 for 2016 and 2017, based on Roth IRA MAGI limits. Individuals age 50 or older, within a particular tax year, can make an additional catch-up contribution of $1,000.
With a Roth IRA, you can withdraw your contributions at any time, free of tax or penalty. Roth IRAs have two types of distributions; qualified and non-qualified distributions. Qualified distributions are tax and penalty free. Distributions are qualified after a five year holding period and age 59 1/2, or as a result of your death, disability, or if using the qualified first time homebuyer exception.
A non-qualified distribution is one that does not meet the above requirements. Does that mean non-qualified distributions are subject to tax and the 10% IRS tax penalty? Not necessarily. Instead, non-qualified distributions follow ordering rules, discussed below. All of your Roth IRAs are aggregated when applying the distribution ordering rules.
– Contributions come first — The first dollars distributed are annual contributions. Because Roth contributions are not deductible, they are not subject to tax or the 10% IRS tax penalty and can be taken at any time.
– Converted dollars are next — After you have exhausted all of your contributions, the next amounts distributed are from any conversions you have completed. These conversion amounts are distributed tax-free on a first in, first out basis. Converted amounts taken before the five-year holding period for each conversion, or you are age 59½ or older, whichever is first, may have a 10% IRS tax penalty, unless an exception applies.
Earnings are last — The last amount is distributed from earnings. Earnings taken before the account has been open for longer than five years and you are at least age 59½, or for your death, disability, or using the first-time homebuyer exception, are subject to tax and the 10% IRS tax penalty, unless another exception applies.
Exceptions to the 10% IRS tax penalty — The exceptions include distributions after reaching age 59½, death, disability, eligible medical expenses, certain unemployed individuals’ health insurance premiums, qualified first-time homebuyer ($10,000 lifetime max), qualified higher education expenses, Substantially Equal Periodic Payments (SEPP), Roth conversion, qualified reservist distribution, or IRS levy.
Need to know more? Take a look at some frequently asked questions about IRAs.
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