You’ve probably heard of a Roth IRA — it’s a retirement account that you can contribute to with after-tax dollars. Though there is no up-front tax break, dividends, interest, and capital gains are tax-free as your account grows. When you make a qualifying withdrawal after you retire (or at age 59 ½), you don’t have to pay taxes!
Let’s talk about some of the significant benefits of a Roth IRA and how one could help you.
Tax-free retirement income
The most obvious benefit of a Roth IRA is that it can help minimize your future tax bill by giving you access to tax-free income during retirement. You have to wait longer for the tax savings payoff, but it can be worth it, especially for those who think their tax rate will be higher later than it is now, due to increases in tax rates or their income potential. When you start making qualifying withdrawals in retirement, you won’t owe any taxes on a Roth IRA account— not even for the earnings on your investments. The money is yours, free and clear.
Minimize or eliminate taxes on your Social Security benefits
Distributions from Roth IRAs after age 59 1/2 from an account that’s at least five years old are not taxable, so they don’t contribute to the taxation of your Social Security benefits. This can be a significant benefit for those looking for potential strategies to minimize taxes on their Social Security payments.
You can access your own money without a penalty before age 59 1/2
You may withdraw your contributions to a Roth IRA penalty-free at any time for any reason. Let’s say you put $6k per year into a Roth IRA for 10 years, for a total of $60k principal contributions. If your Roth IRA grows to $100k, you can access the principal $60k without paying taxes or penalties, unlike a 401(k), traditional IRA, or 403(b). Taxes and potential penalties would apply for the $40,000 of earnings in this example if they were withdrawn before retirement or “the five-year rule”, which can apply if you:
- Withdraw earnings from your Roth IRA
- Convert a traditional IRA to a Roth IRA
- Inherit a Roth IRA
There are several options or “exemptions” where you can access Roth IRA earnings before retirement without paying a 10% penalty.
Your Roth IRA account can pass income tax-free to your heirs
When money is passed down via a traditional IRA or other retirement accounts (like a 401(k)), the requirement to pay federal and state taxes on withdrawals passes down to heirs. However, distributions from an inherited Roth IRA are tax-free.
A Roth IRA is RMD-free
Roth IRAs are not subject to RMDs (required minimum distributions), so you are free to let all your money stay put for as long as you’d like! The big benefit of that is that your investment can continue to grow tax-free.
Tax bracket control
Imagine that you are retired and 100% of your money is in a tax deferred account that you have never paid taxes on.
Also imagine that your income was going to hit $75,525 for the year, $10,000 below 24% tax bracket cutoff ($85,525). Then, suddenly you need to make a $50,000 withdrawal in December for something important to you (family emergency, a down payment on a cabin, etc.).
If all your money is in a tax deferred retirement account, $10,000 of that withdrawal would be taxed at the 24% rate. The remaining $40,000 would be taxes at 32%; that extra 8% just cost you $3,200 in federal income taxes!!!
If you had a Roth IRA with a healthy account balance, you could have taken $10,000 from the IRA, which would have been taxed at the 24% rate and the remainder from the Roth IRA which would have been tax-free and saved you $3,200 in federal income taxes (plus applicable state taxes)!
Contribution limits, income limits, and contribution deadlines
For 2021, the maximum annual contribution an individual can make is $6,000 unless you are 50+ years old. Those 50 and up can contribute up to $7,000 (source).
Eligibility to contribute to a Roth IRA is based on your income level and tax filing status (source):
If you file taxes as a single, head of household, or married filing separately (and you don’t life with your spouse at any time during the year)….
- Your Modified Adjusted Gross Income (MAGI) must be under $125,000 for the tax year 2021 to make a full contribution.
- Your Modified Adjusted Gross Income (MAGI) must be under $140,000 for the tax year 2021 to make a partial contribution.
If you file taxes as married filing jointly or qualifying widow(er)…
- Your MAGI must be under $198,000 for the tax year 2021 to contribute the maximum amount.
- Your MAGI must be under $208,000 for the tax year 2021 to make a partial contribution.
The current deadline for contributing to a Roth IRA for 2021 is April 15, 2022.
Do you wonder if Roth IRA contributions, Roth 401(k) contributions, or Roth IRA conversions could help significantly lower your tax bill or give you more control over your money?
At One Life Financial Group, we can help you create a plan for your money that allows you to enjoy your wealth today while feeling secure about your financial future. We work with small business owners, doctors, and business executives daily to explore opportunities to help protect and grow their wealth.
Contact us today for a complimentary consultation.
**All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication or future results. The information provided is not based on actual current or past clients. All situations are unique, and results will differ depending on individual situation.