A Roth IRA provides different benefits than a Traditional IRA. Unlike a Traditional IRA, contributions to a Roth IRA are never tax deductible. However earnings from a Roth IRA, as well as contributions, are federal income tax-free upon withdrawal if certain conditions are met, allowing you to keep everything you earn for your retirement.
Who is eligible
You must have earned income in order to contribute to a Roth IRA. Unlike Traditional IRAs you may contribute to a Roth IRA after age 701/2. You must also meet the income limits listed below in order to make contributions to a Roth IRA.
Roth IRA contribution limits (refer to image above)
The maximum annual contribution limit is the lesser of 100% of compensation or:
- $5,000 for individuals under age 50
- $6,000 for individuals age 50 and older
The tax-free feature of Roth IRAs can offer substantial additional savings when compared to taxable investments, as the chart below illustrates.
1 The total contribution limit applies to Traditional and Roth IRAs combined.
2 In order to be eligible for tax-free income two conditions must be met. First, it has been at least 5 years since establishing your first Roth IRA and second, you have reached age 59 1/2.
3 “Roth IRA” represents an income tax-free distribution. In this example the “Roth IRA” has been held for more than 5 years and the client has already attained age 591/2. Assumes no state taxes.
4 “Taxable Investment” results are net of an assumed federal income tax rate of 35% and assumes no distributions. Lower tax rates on capital gains would increase the investment thereby reducing the difference in performance between the two accounts.
This hypothetical example is for illustrative purposes only and is meant to show the advantages of a Roth IRA. It is not intended to predict or project investment results.
Income tax-free access to income
You are eligible to begin taking tax-free income from your Roth IRA if:
- It has been at least 5 years since you established your first Roth IRA; and
- You have reached the age of 591/2
Distributions from Roth IRAs, prior to meeting the requirements above, are tax-free until you have withdrawn all your regular contributions. Then, amounts withdrawn are considered to come from converted amounts, if any. When you have withdrawn all your contributions and converted amounts any subsequent withdrawals come from earnings. Withdrawals are subject to income tax and, if made prior to age 591/2, may be subject to a 10% federal income tax penalty. There are however, certain situations the early withdrawal penalty is waived, for instance, if you become disabled or if you are purchasing your first home. It is best to seek the advice of a tax professional when taking a withdrawal if you have not met the 5-year holding period or prior toage 59 1/2.
In Review Roth IRAs offer:
- Tax-free income –After holding the account for 5 years, withdrawals made afterage 59 1/2 are federally tax-free.
- Tax-deferred growth –This creates the potential for assets to increase faster than in a comparable taxable investment account.
- No RMDs – Never have to take distributions during your lifetime.
- No age limit on contributions – Contributions may continue for individuals with earned income after age 70 1/2.