Understanding Roth IRAs
What you need to know before you decide to contribute
What Is a Roth IRA?
A Roth IRA is a type of Individual Retirement Account (IRA) to which you make contributions with after tax money, meaning earnings you’ve already paid taxes on. The money you put into your Roth IRA grows tax-free and, assuming you have met certain conditions, your withdrawals are tax-free and not reported in your taxable income.
How is this different from a Traditional IRA?
In contrast to a Roth IRA, contributions to a Traditional IRA are tax-deductible. Your contributions to a Traditional IRA grow tax-deferred, but when you take money out of a Traditional IRA you pay ordinary income taxes on the amount you withdraw.
Who can contribute to a Roth IRA?
Anyone who has earned income - income you receive from working such as salaries, bonuses, wages, commissions and tips - and has not already contributed to a Traditional IRA for the year may be able contribute to a Roth IRA.
If your tax-filing status is single and your Modified Adjusted Gross Income (MAGI) in 2019 is $122,000 or less, you can make a full contribution to a Roth IRA. If your MAGI is $137,000 or more, you cannot contribute to a Roth IRA. The MAGI limits for 2018 are $120,000 and $135,000, respectively.
If your tax-filing status is Married Filing Jointly (MFJ) and your MAGI in 2019 is $193,000 or less, you can make a full contribution to a Roth IRA. If your MAGI is $203,000 or more, you cannot contribute to a Roth IRA. The MAGI limits for 2018 are $189,000 and $199,000, respectively. A non-working spouse may be able to open and contribute to a Roth IRA based on the working spouse’s earnings and the couple’s tax filing status.
If your tax-filing status is Married Filing Separately (MFS) you are not eligible to make a Roth IRA contribution if your MAGI is greater than $10,000 and you lived with your spouse at any time during the year.
How much can I contribute to a Roth IRA?
The amount you can contribute to a Roth IRA is the lesser of your earned income or $6,000 in 2019 ($7,000 if you are age 50 or older), provided you meet the MAGI tests noted above. You can make contributions for 2019 at any time during the calendar year and up until the tax filing deadline of April 15th of the following year. You still have time to make a contribution for the 2018 tax year, as well. The 2018 Roth IRA contribution limit is $5,500 or $6,500 for those age 50 or older.
When can I take money out of my Roth IRA?
You are able to withdraw your contributions tax and penalty free at any time.
To be able to withdraw earnings on your contributions tax and penalty free, certain conditions must be met. First, the Roth IRA must have been opened for at least five years. In addition to the five year test, you must also satisfy one of the following conditions: age 59 ½, death, disability, or you are a first time homebuyer (up to $10,000 limit).
Do I have to take withdrawals from my Roth IRA like I would a Traditional IRA?
No, you don’t. Roth IRAs are not subject to the same Required Minimum Distribution (RMD) rules that Traditional IRAs owners face when they turn 70 ½. However, if you have inherited a Roth IRA from someone else, you are subject to RMDs regardless of your age.
Why should I contribute to a Roth IRA instead of a Traditional IRA?
With both types of accounts, you have to pay taxes. With a Roth IRA, you pay taxes on the dollars before you fund the Roth IRA, but you don’t pay taxes on the compounded growth or any withdrawals in retirement (provided you meet the tests listed above). With a Traditional IRA, you get the upfront tax-deduction for the tax year when you make the contribution, but you have to pay taxes in retirement on the entire amount withdrawn from the account.
There are pros and cons to contributing to a Roth IRA vs a Traditional IRA and your specific goals and circumstances will determine the best approach. Workers tend to be in their lowest earning years when they are young adults, which is a great time to open and fund a Roth IRA. Not only are you locking in that lower tax bracket, but by starting contributions early on the account balance has a much longer time period to grow
Another consideration would be tax diversification or investing in pre-tax and/or after-tax investment accounts during your earnings years, depending on which vehicle is appropriate at that time (or both). In addition, you have the flexibility to withdraw contributions at any time and you’re not required to withdraw from the Roth IRA at age 70 ½. In fact, if you’re still working at that age, you can continue to contribute.
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