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roth ira rules

A Roth IRA can be a great way to stash away savings for your retirement. Like all tax-advantaged retirement plans, however, the IRS has rules and requirements governing how they’re used. These include rules regarding the taxation of contributions and withdrawals. There are also limits on how much you can contribute in a given year, as well as income limits for participating in these plans. We’ll walk you through these rules, show how Roth IRAs differ from traditional IRAs, and help you understand how these rules impact your savings.

Roth IRA Basics

Let’s review the basics of the Roth IRA. Like a traditional IRA, this is a retirement account you open yourself at a brokerage. Where they differ, though, is in their tax treatment. Unlike a traditional IRA, which allows for a tax deduction, a Roth IRA is funded with after-tax dollars. You can’t deduct your Roth IRA contributions from your taxable income.

So why would you open one? The benefit is that you can make tax-free withdrawals once you retire. While there’s no upfront deduction, your after-tax contributions grow and compound over time and then can be withdrawn with no income taxes whatsoever.

That’s the most basic feature of the Roth IRA. Let’s go into more depth on the many rules surrounding these accounts.

You Can Withdraw Money Before Retirement

All About Roth IRA Rules

With a traditional IRA, you’ll pay a penalty if you take withdrawals before you hit age 59.5. With a Roth IRA, though, you can withdraw your contributions at any time without paying a penalty. Keep in mind that you can only withdraw up to the amount you contributed. You can’t withdraw earnings until you hit 59.5. That means you’ll need to keep track of how much you contribute to your Roth account, or risk withdrawing too much and paying for it.

There are a few instances in which you can withdraw earnings without paying a penalty. You won’t pay a penalty if you’re withdrawing funds because of a disability. The IRS defines being disabled as being unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long continued and indefinite duration.

Other exceptions include:

  • If you die.
  • If you start a SEPP program.
  • Paying for medical expenses that account for more than 7.5% of your adjusted gross income (AGI).
  • Paying medical insurance premiums while receiving unemployment for more than 12 weeks.
  • Making your first purchase of a home.
  • Paying for qualifying higher education expenses.

You Can Withdraw Money in Retirement Without Paying Income Taxes

Since the money you contribute to your Roth IRA is after-tax money, you don’t have to pay taxes again when you start taking distributions from the account in retirement, provided you have had the Roth IRA for at least 5 years and have hit age 59.5. Tax-free withdrawal makes the Roth a great way to diversify your tax risk in retirement.

If you have a 401(k) through work, you’ll pay taxes on that money when you start taking distributions in retirement. Opening a Roth on the side will give you both a pre-tax retirement account and a post-tax account. If you’re not sure if you’ll be in a higher or lower tax bracket in retirement, having both types of accounts allows you to hedge your bets.

The younger you are when you open your Roth IRA, the more you stand to gain. You’ll benefit from the magic of compound interest, and from more years of gains that are never taxed. Plus, most people make less money when they’re younger, which means the tax they pay on those contributions are likely lower.

There Are Income and Contribution Limits

Yes, there are income caps on Roth IRAs. The IRS income eligibility range tells you whether you can make a) the maximum contribution to a Roth IRA ($6,000 in 2020), b) a partial contribution or c) no contribution.

For 2020, the phase-out income range for a married couple filing together is $196,000-$206,000. For those filing on their own, the range is $124,000 to $139,000. If your income is below the bottom of the range, you can contribute the full $6,000. Should your income fall within the range, you are subject to contribution phase-out rules, meaning that you won’t be able to contribute the full $6,000, but can contribute a partial amount. If your income is above the top of the phase-out range, IRS rules prohibit you from contributing to a Roth IRA.

Note that if you’re over 50, you can contribute an extra $1,000 on top of this limit. If you want more Roth action in your life but you’ve hit the Roth IRA contribution limit, consider contributing to a Roth 401(k).

You Can Open a Backdoor Roth

Let’s say your income makes you ineligible for a Roth IRA. You can still take advantage of what’s called a backdoor Roth. With a backdoor Roth, you contribute to a nondeductible traditional IRA and then roll it over into a Roth IRA. Ta-da! You have a Roth, and all the tax advantages that come with it. 

You Don’t Have to Take Required Minimum Distributions

All About Roth IRA Rules

Traditional IRAs come with Required Minimum Distributions (RMDs). That means that when owners of traditional IRAs hit age 70.5, they’re required to start taking money out of their account, even if they don’t need that money and don’t feel like paying taxes on that money. Not so with the Roth IRA, which doesn’t have any RMDs. If you don’t need the money right away in retirement, you can let it keep growing tax-free until you do.

You Don’t Have to Stop Contributing After Age 70.5

Not only can you leave your money in a Roth well into retirement, you can even keep contributing. With a traditional IRA, you have to stop making contributions at age 70.5. Roth IRAs come with no such rules. You can contribute to them for as long as you live, making them valuable assets for folks who want to build up wealth to transfer to their heirs.

The Takeaway

The Roth IRA can be a great retirement savings option for anyone who wants to reduce his or her tax burden in retirement and benefit from years of tax-free growth in the meantime. If you think you’ll be in a higher tax bracket in retirement than you are now, saving in a Roth can be a particularly smart move.

Not sure how your tax bracket will compare in retirement? We get it. No one can predict with 100% certainty what tax policy changes lie ahead. But if you’re already contributing to a tax-deferred account like a 401(k), it might be a good idea to hedge your bets with a Roth. And even if your effective tax rate does wind up being lower in retirement, the benefits of decades of tax-free growth might still make a Roth worth it.

Tips for Saving for Retirement

  • Before you start contributing to an IRA, max out any employer match offered on your 401(k). Employer matching is free money, so don’t pass that up! With that additional boost, your 401(k) balance will grow even larger over time.
  • Working with a financial advisor can help you determine the best accounts and investments to reach your retirement goals. SmartAsset’s financial advisor matching tool can help connect with you an expert in your area. Just answer a few questions about your financial life, and we’ll match you with up to three local advisors for you to review and interview.

Photo credit: ©iStock.com/monkeybusinessimages, ©iStock.com/annebaek, ©iStock.com/Jason York

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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