Grow Your Nest Egg Tax-Free with a Roth IRA
Opening a Roth individual retirement account, or Roth IRA, allows you to set aside after-tax income that can grow tax-free for retirement. Contributions to a Roth IRA are not tax deductible, but qualified withdrawals in retirement are tax-free.
This differs from a traditional IRA, where contributions may be tax deductible but withdrawals in retirement are taxed as income. The tax-free growth and withdrawals make the Roth IRA an appealing way to build up retirement savings.
Who Can Contribute
If your modified adjusted gross income is below $146,000 as a single tax filer or $230,000 if married filing jointly, you can contribute the full $7,000 annual amount if you’re under age 50. The limit is $8,000 a year if you’re 50 or older.
Income limits phase out above those thresholds up until the point you can no longer contribute. Fortunately, options still exist to fund a Roth IRA when income is too high to contribute directly, including converting a traditional IRA and making after-tax contributions to a 401(k) for later rollover into a Roth IRA.
Tax-Free Growth
Once money goes into your Roth IRA, any investment returns accumulate tax-free. This allows your savings to compound more quickly than taxable accounts. For example, if you contribute $6,000 per year for 30 years and earn a 6% annual return, you would accumulate approximately $475,000. With taxable growth, that amount would be reduced by taxes along the way.
Flexible Access
Unlike workplace retirement accounts like 401(k)s, you can withdraw your Roth IRA contributions tax- and penalty-free anytime. While you don’t want to routinely tap retirement savings, this flexibility provides peace of mind.
Investment earnings can also be withdrawn early without tax or penalty in certain circumstances like a first home purchase, higher education expenses, or the birth of a child.
Qualified Withdrawals
As long as you’ve held your Roth IRA for five years and are at least 59 and a half, all withdrawals are tax-free in retirement. This includes both your contributions and any investment returns.
Required minimum distributions also don’t apply to Roth IRAs as they do with traditional IRAs, allowing your savings to continue growing tax-free over your lifetime.
Rollovers
If you have money in a 401(k) or traditional IRA, you may move those funds into a Roth IRA. This conversion would be a taxable event, but it allows you to lock in future tax-free growth. When changing jobs, you can also roll a Roth 401(k) into a Roth IRA to maintain tax-free status. Consolidating your Roth retirement funds into a Roth IRA gives you more investment options and flexibility.
Beneficiary Options
Roth IRAs allow more flexibility for beneficiaries than other retirement accounts. Spouses can inherit the account tax-free and even treat it as their own Roth IRA with the potential for continued tax-free growth. Non-spouse beneficiaries can take withdrawals over their lifetime, allowing the savings to continue growing tax-deferred. This contrasts with inherited traditional IRAs that require faster distribution.
Investment Options
While access, tax treatment, and beneficiary options provide advantages, Roth IRAs also allow you to invest contributions however you choose. This allows you to customize an investment portfolio to your risk tolerance, unlike limited investment options with some workplace retirement plans. Over long time horizons, strategic investing can enable greater growth potential.
Conversions
If income limits prevent you from directly contributing to a Roth IRA, you can open a traditional IRA, take a deduction on your contributions if eligible, and then convert the traditional IRA to a Roth IRA. While tax is due on conversion, future growth becomes tax-free.
Many IRA providers allow you to convert existing IRAs held with other institutions. When considering conversion, be aware of the five-year holding period to avoid taxes and penalties on earnings.
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