Roth IRA Vs. Traditional IRA
How do I qualify for a Roth IRA?
As a single taxpayer, you simply need to have a Modified Adjusted Gross Income (MAGI) of less than $129,000 to make the maximum contribution. Contribution amounts are reduced as your income approaches $144,000, after which you no longer qualify for a Roth IRA. For married taxpayers filing jointly, full contribution is available up to a MAGI of $204,000 with reductions up to full elimination at $214,000.
How does a Roth IRA develop?
A Roth IRA grows like any other investment account, through the magic of compounding. Your contributions to a Roth IRA are invested to earn interest, and that interest helps increase your overall portfolio balance, helping to earn more interest. The longer your money has in the market, the better the chances of getting better returns over time. The money in a Roth IRA can continue to grow even after you stop making contributions because the ongoing returns continue to add to the balance and be reinvested. The financial institutions reviewed for this article all provide resources and advice on diversifying a portfolio to ensure the right balance of risk and reward for smartly growing your retirement savings in a Roth IRA.
Why should you consider a Roth IRA?
Roth IRAs are a powerful variation of the traditional IRA from a tax perspective. Unlike a traditional IRA where you get a tax deduction based on your contributions up to the limit, Roth IRA contributions are made after tax. This means that the tax on the money in your Roth IRA is already paid, so there is no tax to pay when you withdraw your money. Simply put, all growth in a Roth IRA is tax-exempt. You will not pay capital gains in retirement as long as you meet the qualified distribution guidelines.
While many people choose to take advantage of the deduction now and pay taxes on retirement savings when they withdraw funds in the future, this strategy is disadvantageous if you have income from other sources in the future. retirement. If you have a 401(k), a pension, an investment portfolio, rental real estate, or simply choose to keep working until you reach your golden years, traditional IRA distributions may push you to pay more taxes than you would with a Roth IRA. Since it is difficult to accurately imagine your sources of income in the decades to come, there is a mechanism for converting a traditional IRA to a Roth IRA. While these conversions have tax implications, it often makes sense to do so sooner rather than later if your retirement income appears to be higher than what you are earning now. If you’re unsure, it’s usually worth talking to a financial advisor about your particular situation.
Who are Roth IRAs for?
Roth IRAs are best for those whose Modified Adjusted Gross Income (MAGI) is below or within the ranges, but contribution space is reduced when you reach the upper limits of the ranges. The limits for 2022 are:
- $6,000 ($7,000 if over 50) for those with income of $129,000 or less as single filers with a gradual reduction to zero contribution at $144,000
- $6,000 ($7,000 if over 50) for married taxpayers filing jointly earning up to $204,000 with a gradual reduction to zero at $214,000
Roth IRAs also make sense if you expect to have a large income in retirement. A common strategy is to withdraw all taxable contributions from other plans to stay within a set tax bracket, then use the Roth IRA as a top-up when needed for lifestyle reasons. From a tax perspective, your goal in retirement is to have accounts with a zero tax burden by the end of your life and to have your financial legacy set up in a way that minimizes tax liability. inheritance tax for your heirs. The Roth IRA is an ideal tool for this role.
Can I use a Roth IRA as an emergency fund?
An often overlooked feature of a Roth IRA is its ability to function as a de facto emergency fund. Since you are making contributions with after-tax dollars, you can withdraw these contributions without any tax implications. This only applies to the amount contributed, of course, and any income on that money must remain in the account until you can make a qualified distribution. Nevertheless, the contribution space allows you to have the peace of mind of a large retirement fund that doubles as an emergency fund if you need it.
How do Roth IRAs provide tax diversification in retirement?
Many people assume that your taxable life ends with your working life, but taxation covers your whole life and a bit beyond. As your work income disappears and you start withdrawing from a 401(k), for example, those distributions become your reported taxable income. Any other income, including dividends, royalties, bond interest, etc., will increase this taxable income.
Taking a part-time contract, something much more common for retirees now, can also overlap the required minimum distributions (RMDs) of traditional IRAs. The result is an uncomfortable situation where every dollar earned through enjoyable work in retirement is diminished by taxes, discouraging some retirees who wish to continue doing meaningful work from doing so. In a Roth IRA, however, you can still supplement any retirement income with your retirement savings without affecting your tax position.
Do Roth IRAs have required minimum distributions (RMDs)?
A huge advantage to structuring your retirement account as a Roth IRA is that there are no required minimum distributions (RMDs). This means you can simply leave the money in the Roth IRA if you don’t need it immediately in retirement. If you passed before you’ve fully used up the money in your Roth IRA, it would be transferred to your designated beneficiary. If it is your spouse, the same rules apply as for you (no taxes and no RMD). The Roth IRA can actually be passed on to your heirs without incurring estate taxes, although there are certain rules about how and when they must start withdrawing it.
Investopedia is dedicated to providing investors with unbiased and comprehensive online brokerage reviews and ratings. Our reviews are the result of six months of evaluating all aspects of an online broker’s platform, including user experience, quality of trade executions, products available on their platforms, costs and fees, security, mobile experience and customer service. We established a rating scale based on our criteria, collecting over 3,000 data points which we weighted in our star rating system. Click here to read our full methodology.