The Roth IRA was introduced in the 1990s and has since become one of the most popular retirement savings tools. Much of the Roth’s popularity comes from its unique tax treatment, which differs greatly from that of a traditional IRA.
In a traditional IRA, your upfront contributions are deductible, as long as you meet income requirements. Your funds grow tax-deferred as long as they stay in the account. Your distributions from the traditional IRA are then taxed as ordinary income.
In a Roth IRA, there are no deductions for upfront contributions. Your funds still grow tax-deferred as long as they are inside the account. Roth IRA distributions are tax-free, however, as long as you are over age 59½ and the account has been open at least five years. That means you can use a Roth IRA today to save money and create tax-free income in retirement.
Tax treatment is the biggest difference between a traditional IRA and a Roth, but it’s not the only difference. Below are three other important distinctions you may want to know before you start saving with a Roth IRA:
The Roth IRA has income limitations.
Not everyone can use a Roth as a savings vehicle. Roth IRA contributions are governed by income limitations. If you’re a high earner, you may not be able to contribute to a Roth.
In 2017, married couples who make more than a combined $196,000 can’t contribute to a Roth. Those who make less than $186,000 can contribute as much as $5,500. Couples who make between $186,000 and $196,000 can contribute a reduced amount.1
Single filers can contribute the full amount to a Roth if they earn up to $118,000. Contribution limits are then reduced for singles who earn between $118,000 and $133,000, at which point contributions are no longer allowed.1
There are no taxes or penalties if you withdraw your contributions.
In nearly all qualified accounts, such as IRAs and 401(k) plans, you are not allowed to take distributions before age 59½. Doing so could result in a 10 percent early distribution penalty. This penalty is in place to encourage people to use the accounts for their intended purpose of saving for retirement.
However, the Roth has a unique feature that allows you to take some portion of your funds before age 59½ for any reason. Your Roth contributions are made with after-tax dollars, since you receive no upfront deduction. That means you can withdraw your contributions at any time without paying taxes or an early distribution penalty.
Keep in mind that if you do withdraw your contributions early, you could limit your growth potential in the future. Those dollars will no longer be invested inside the account and won’t have the ability to accumulate. If you really need the funds, however, you could take advantage of this unique rule.
You aren’t required to take distributions at age 70½.
The traditional IRA has what are called required minimum distributions (RMDs) that take effect at age 70½. Once you reach that age, you are required to take a minimum amount from your traditional IRA. The amount is based on your life expectancy and your account balance. As you get older, the percentage of your balance that you’re required to withdraw each year gradually increases.
Roth IRAs don’t have RMDs. Required minimum distributions are in place to ensure that traditional IRA owners pay taxes on their funds. Roth IRA distributions aren’t taxable, however, so there’s no reason to enforce RMDs. With a Roth, you can keep the funds in your account as long as you’d like, and even pass them down as a tax-free benefit to your loved ones.
Ready to create a savings strategy using a Roth IRA? Let’s talk about it. Contact us today at Legacy Retirement Services. We can help you analyze your needs and create a plan. Let’s connect soon and start the conversation.
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Terry L. Tyler