Roth IRAs are an excellent retirement vehicle that allows you to enjoy your returns and distributions tax-free. However, not everyone is eligible for Roth IRA contributions. Additionally, some workers might favor a prompter tax cut.
US News My Money explains how to open a Roth IRA.
Meet The Eligibility Requirements
Before you can contribute to a Roth IRA, you must have an income. But if you earn over a certain amount, you’ll be ineligible. In 2021, Roth IRA eligibility will taper off for individuals earning $125,000 or more ($198,000 for couples filing jointly). If you make more than $140,000 as a single-filer or $208,000 as a couple, you cannot make direct contributions to a Roth IRA.
But, there are ways that higher-income workers could get around the income restriction. According to Martin Lundgren, a certified financial planner and president of Seattle-based Northern Lights Advisors, you could rollover your assets from a traditional IRA to a Roth IRA, though you would have to pay taxes on the funds you converted.
“Folks who make a high income over those limits, if they want to contribute to a Roth IRA, you can do a backdoor Roth conversion,” he told US News My Money.
Review The Roth IRA Contribution Caps
If you are 49 years or younger, you can contribute up to $6,000 to your Roth IRA next year. Individuals older than that can contribute an extra $1,000 as a catch-up contribution for a total annual contribution of $7,000.
If your contributions surpass these caps, you will be charged a 6% excise tax on the extra funds. To prevent this penality, make sure to withdraw those additional contributions before your tax return’s deadline.
Meet The Roth IRA Contribution Deadline
You must make your contributions before April 15, which is generally the last date to file your taxes. If you deposit money to your Roth IRA between January and April 2021, you must state if it is a 2020 or 2021 contribution on your return.
Determine If The Roth IRA Tax Break Is Right For You
Roth IRAs differ from traditional IRAs in that they don’t offer tax deductions the year you made contributions. But, the funds in your account will grow tax-free, and you also don’t have to pay taxes on distributions after 59 ½ if your account is five years or older.
Alex Doll, a certified financial planner and the president of Anfield Wealth Management in Cleveland, explained. “Roths are funded with post-tax money that you have already paid tax on today, so you will not have to pay tax on it again in the future.”
When choosing between traditional and Roth IRAs, compare your present tax rate to your future one in retirement. With a Roth IRA, you can secure your current tax rate and dodge additional taxes on your nest egg in the future.
“If you believe you are in a higher tax bracket now than you will be when you take the money out of your IRA, you should use a traditional IRA,” Doll continued. “And if you think you are in a lower tax bracket today than you would be in the future, you should use a Roth IRA.”
According to Luiz Augusto Pachero, a Miami-based certified financial planner at Brainvest Wealth Management, younger workers with smaller incomes stand to benefit the most from Roth IRAs, as they have many years for their savings to grow. “Usually when you start your career, your income is lower, and so is your tax bracket. So, it would be better to go the Roth route and take benefit of that.”
Decide When You Will Withdraw Your Funds
Traditional IRAs require savers to make annual distributions beginning at age 72. However, Roth IRAs don’t have this same stipulation, which means you can let your funds continue to grow without paying taxes until you’re ready.
“When you take that money out in retirement, it has already been taxed and it doesn’t add to your taxable income at all,” Lundgren noted. “If you really don’t need the Roth IRA assets in your lifetime, they can be inherited.”
So if you leave your nest egg as an inheritance, your beneficiaries won’t have to pay taxes on the distributions, either.
Compared to their traditional counterparts, Roth IRAs let you pay fewer taxes and fees if you need to withdraw money before turning 59 ½. As long as the account is five years or older, you won’t pay the penalty. The 10% for early distributions is only for withdrawals of investment returns unless you spend the funds for a qualifying reason.
Justin Porter, a certified financial planner who founded Porter Wealth Management in Calhoun, Georiga, told US News My Money, “You can tap the earnings penalty-free for a future home purchase, higher education expenses for you or a family member or health insurance premiums while you are unemployed. You just need to have the account open for five years in order to qualify for penalty-free distributions of contributions. I recommend opening the account as early as possible to start the five-year clock, even if that means funding it with a nominal amount in the first year.”
Compare Products From Several Financial Institutions
Most banks and credit unions offer Roth IRAs. Take your time comparing a variety of institutions before opening an account. Check for investment options you prefer and affordable fees.
“The lowest-cost option typically requires you to manage the portfolio yourself,” Doll said. “In that case, I recommend they go directly to a big firm that offers low-cost index funds with commission-free trades, such as Schwab, Fidelity, Vanguard or TD Ameritrade.”
If you’re unsure where to start, you might consider working with a financial planner or a robo advisor to make the process easier.
- Brandon, Emily. “How to Open a Roth IRA.” U.S. News & World Report, U.S. News & World Report, 14 Dec. 2014, money.usnews.com/money/retirement/iras/articles/how-to-open-a-roth-ira.