Key Points
Given the number of rules surrounding Roth IRAs, sometimes it may be hard to separate fact from fiction.
Roth IRAs aren’t just for young workers. Regardless of age, a Roth can benefit anyone’s portfolio.
If your income is too high to directly take advantage of a Roth IRA, there are workarounds.
The $23,760 Social Security bonus most retirees completely overlook ›
Whether you opened a Roth IRA years ago or have had your eye on one, you probably have a sense of what a great investment vehicle it is. A Roth IRA allows you to contribute money you’ve already paid income tax on (after-tax dollars). Then, if the account has been open at least five years, you can withdraw funds after age 59 1/2 and pay no taxes on the withdrawal or earnings.
Roth IRAs can be an attractive addition to your portfolio, but boy, are they surrounded by rules and regulations. There are so many that it’s easy to become confused, believing rumors and myths about this investment powerhouse. Here are some of the most common Roth IRA myths, followed by the true scoop.
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Myth: You can only contribute to a Roth IRA if you have a paid job
The truth is: If you’re a non-working spouse, it’s possible to open a Roth IRA in your own name and contribute to it based on your spouse’s income alone.
Myth: Roth IRAs are only for young people, years away from retirement
The truth is: Roth IRAs offer young workers an excellent investment opportunity. Not only are they likely to pay less in taxes (due to being in a lower income bracket), but they also benefit from tax-free growth over time.
However, a Roth IRA can benefit anyone of any age, particularly those who expect their income to increase over time and want to take advantage of a lower tax rate while they can.
Myth: Contributions to a Roth IRA absolutely cannot be withdrawn until retirement
The truth is: Once your account is at least five years old and you’re 59 1/2 or older, you can withdraw contributions (not earnings) without paying taxes or penalties. This makes a Roth IRA a more flexible investment than many.
However, earnings may be subject to taxes and penalties if you withdraw money before age 59 1/2 or before you’ve had the account for five years.
Myth: High earners can’t take advantage of Roth IRAs
The truth is: Due to the special tax considerations, there are contribution and income limits set on Roth IRAs. In short, whether you can contribute to a Roth IRA or benefit fully from a Roth IRA depends on your modified adjusted gross income (MAGI) and tax filing status. For example:
Filing Status | Eligible for Full Contribution if Your MAGI Falls Below… | Eligible for a Partial Contribution if MAGI Is Between… | Not Eligible for Contribution if Your MAGI Is Greater Than… |
|---|---|---|---|
Single/Head of household | $150,000 | $150,000-$165,000 | $165,000 |
Married filing jointly | $236,000 | $236,000-$246,000 | $246,000 |
Married filing separately | Not eligible | Less than $10,000 | $10,000 or more |
Data Source: Vanguard.
However, there’s a workaround for high earners who expect to have greater income in their retirement years. It involves taking funds from a traditional IRA, paying ordinary taxes on those funds, and rolling them into a Roth IRA from which the money can be withdrawn later tax-free.
Myth: Heirs won’t benefit from a Roth IRA
The truth is: While rules regarding beneficiaries changed a bit this year, Roth IRAs remain an attractive way to transfer wealth without your heirs having to worry about paying income tax on the distributions. Here’s a look at those changes and how they apply to non-spouse beneficiaries:
Non-eligible designated beneficiaries must make yearly withdrawals. Failure to do so will result in a 25% penalty on the amount not distributed.
A new “10-year rule” applies to most non-spouse beneficiaries. As the name suggests, the 10-year rule requires heirs to fully withdraw the entire balance of the inherited Roth IRA within 10 years of your death.
Some heirs are considered “eligible designated beneficiaries,” and the 10-year rule does not apply to them. These include surviving spouses, individuals less than 10 years younger than you when you pass, disabled or chronically ill beneficiaries, and your minor children until they reach the age of majority.
Roth IRAs may be wrapped in a layer of rules and regulations, but they remain an effective way to save, especially if you’re watching out for higher taxes in retirement.
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