Investment Advisor Explains: Roth IRAs

Hey Creative Investor, 

Are you considering a Roth IRA? It's a great step towards growing your retirement savings, and we're here to make it simple and clear for you.

In 5 min or Less:

1. A Roth IRA permits you to invest post-tax income, enabling tax-free withdrawals after age 59 1/2.
2. It has no age restrictions; eligibility depends on income.
3. Unlike traditional IRAs, it lacks mandatory minimum distributions, allowing your investments to grow undisturbed.
4. Qualified beneficiaries can make penalty-free withdrawals from an inherited Roth IRA, though taxes may apply to earnings.

What Is a Roth IRA?

A Roth IRA, short for Individual Retirement Account, is like the rock star of retirement accounts.

It allows you to set aside a certain amount each year for your retirement.

What sets it apart are the fantastic tax advantages it offers—tax-free growth and tax-free withdrawals in retirement.

It's a sweet deal!

How Does a Roth IRA Work?

With a Roth IRA, you fund the account with after-tax dollars, meaning you've already paid taxes on the money.

The significant benefit? You won't pay any taxes when you use that money in retirement, and all the growth on your contributions remains tax-free.

This is a game-changer—withdrawals after age 59 1/2 are tax-free, provided you've had the account for more than five years.

Who's Eligible for a Roth IRA?

It's straightforward.

If your income falls below the Roth income requirements (we'll delve into those shortly), you're eligible.

Age doesn't matter; whether you're 17 or 92, as long as you're earning income, you can contribute.

Advantages of a Roth IRA:

Let's talk taxes. Contributions are made after taxes, allowing your investments to grow tax-free.

This is especially beneficial if you expect to be in a higher tax bracket during retirement.

Other perks include no mandatory withdrawals at a certain age (unlike traditional IRAs) and the ability to choose beneficiaries who can inherit the account tax-free.

Roth IRA vs. Traditional IRA: How Do They Compare?

The key difference lies in taxation. Roth IRAs are funded with after-tax dollars, offering tax-free growth and withdrawals.

In contrast, traditional IRAs use pretax money, resulting in taxes on withdrawals in retirement. We've provided a side-by-side comparison for your convenience.

IRA Comparison Chart

2023 Roth IRA Contribution Limits:

For 2023, the maximum contribution to a Roth IRA or traditional IRA is $6,500, rising to $7,500 if you're 50 or older.

Rolling over your 401(k) to a Roth IRA doesn't count toward your contribution limit, but it's wise to consult your financial advisor for tax implications.

2023 Roth IRA Income Limits:

Uncle Sam sets limits. If your income exceeds these limits, your contribution amount may be reduced or disallowed entirely.

We've detailed the 2023 Roth IRA income and contribution limits to help you navigate.

Income Limit Comparison Chart

Roth IRA Withdrawal Rules: 

Withdrawal rules can be tricky. Here is a comprehensive overview of when and how you can withdraw from your Roth IRA, covering early withdrawal rules and the five-year rule.

Roth IRA Beneficiary Rules:

The rules for Roth IRA beneficiaries have changed due to the SECURE Act.

Now, only specific qualified beneficiaries can leave inherited funds in a Roth IRA for over 10 years after the original owner's death.

These include the spouse of the original owner, minor children, disabled or chronically ill individuals, and those not more than 10 years younger than the original owner.

If a beneficiary doesn't meet these criteria, they must withdraw all funds within 10 years.

There's no penalty for beneficiaries younger than 59 1/2, but if the Roth IRA was held for less than five years, earnings may be subject to tax upon withdrawal.

How to Open a Roth IRA: 

Practical steps! To open a Roth IRA, gather essential information, choose a beneficiary, and contribute funds—either as a lump sum or monthly. 

You'll need to provide personal information such as your driver's license, Social Security number, bank details, and your employer's information.

During the setup process, you'll also designate beneficiaries who will inherit the account if needed.

You can fund your Roth IRA with a lump sum or set up monthly deductions, but ensure you stay within the annual contribution limit.

If you don't already have a custodian, then consider a reputable outfit like Fidelity or TD Ameritrade. (I don't earn anything for saying this).