We all want to retire someday, but the retirement planning process can be intimidating. We, at Blue Chip Partners, want to change that. Our goal is to help you understand the tools you can use to move closer to your retirement goals and become financially independent. In this series, we focus on the Roth IRA and how it can become an essential tax and estate planning tool as you prepare for and move into retirement.
The Roth IRA differs from a traditional IRA in several important ways. The following discussion of the most common questions about traditional and Roth IRAs can help you understand the role each can play in retirement planning and wealth management. We will be discussing these issues and how they impact wealth management in more depth in future posts.
If you are single, you can contribute a maximum of $6,000 per year or the amount of your earned income for that year, whichever is less. Taxpayers with the tax filing status of married filing jointly may each contribute up to $6,000 per year as long as one of the spouses has at least $12,000 in earned income. However, these contributions may not be tax deductible depending on your income level and if you or your spouse are covered by an employer retirement plan.
Your ability to contribute to a Roth IRA depends on your income.
If you file taxes as single or head of household, you can contribute up to $6,000 per year to a Roth IRA as long as your earned income exceeds $6,000 AND your modified adjusted gross income (MAGI) is less than $125,000 for the 2021 tax year and less than $129,000 for the 2022 tax year. These contributions are not tax deductible.
If you are married filing jointly, each spouse can contribute up to $6,000 per year as long as your earned income exceeds $12,000 AND your MAGI is less than $198,000 for 2021 and less than $204,000 for 2022. These contributions are not tax deductible. Your allowable direct contributions to a Roth IRA will be reduced or eliminated if your income is above these limits.
Earned income includes wages, salaries, tips, commissions and self-employment income. Earned income does not include interest and dividends, pensions and annuities, welfare benefits, unemployment compensation, worker's compensation benefits or Social Security benefits.
Yes, you can contribute an extra $1,000 per year to a traditional IRA if you are 50 or older. Whether this amount is tax deductible will depend on your income.
Yes, you can contribute an extra $1,000 per year to a Roth IRA if you are 50 or older and meet the income limits for contributions. However, these amounts are not tax deductible. The age 50+ catch-up contribution amounts for both traditional and Roth IRAs may change in the future.
Yes, you can make a contribution to a traditional IRA in any year you have earned income from employment, even if it is part-time work or some amount earned through freelance or contracting work for which you receive a 1099 tax form for your earnings. However, your contribution cannot be higher than the amount of money you earned that year.
Yes, you can make a contribution to a Roth IRA in any year you have earned income from employment that falls within the overall maximum income limits for contributions. Your contribution cannot be higher than the amount of money you earned that year.
You can contribute to a traditional IRA no matter how much you earn, but you may not be able to deduct those contributions from your taxes.
There are three potential ways to take advantage of a Roth IRA if you make more than the income limits for contributions.
Convert a traditional IRA to a Roth IRA. You can convert amounts you have already saved in a traditional IRA into a Roth IRA. This conversion requires you to pay income taxes on the dollar amount converted from the traditional IRA into the Roth IRA. You may convert the entire traditional IRA balance at once or make multiple conversions over time.
Leverage your employer retirement plan. Your workplace 401(k) or 403(b) retirement plan may allow you to make Roth contributions. Ask your employer or plan administrator if this is an option for you. Income limits do not apply to retirement plan Roth contributions; however, elective deferrals within your retirement plan are subject to contribution limits.
Open the “back door.” A “backdoor” Roth IRA allows you to fund a Roth IRA even if your income is above IRS limits. The backdoor Roth IRA occurs when you make a nondeductible contribution to a traditional IRA, then subsequently convert those funds over into a Roth IRA. Since you do not receive the benefit of a tax deduction on the original contribution, the rollover is not considered to be taxable income. This process is reported by completing IRS Form 8606 and attaching it to your tax return.
It is important to note that there is some uncertainty about how long backdoor Roth IRAs will be allowed to continue. There have been ongoing discussions about federal tax law changes that could curtail or eliminate this option in the future. However, until those changes are signed into law, the backdoor Roth remains an option.
In general, you can make penalty-free withdrawals from a traditional IRA when you reach age 59-1/2. These withdrawals will be taxed as regular income. You may be able to make withdrawals earlier under certain circumstances. When you reach age 72, you will have to begin taking required minimum distributions (RMDs) that are calculated using a specific table based on your age.
You can withdraw any amount from your Roth IRA without penalty or having to pay taxes as long as you are age 59-1/2 or older and the money has been in the account for at least five years. The original owner of a Roth IRA is not required to take distributions in their lifetime.
You can name beneficiaries for your traditional IRA. Your heirs will have to make certain required account distributions and pay income taxes on those distributions.
In general, your heirs will be able to withdraw funds from an inherited Roth IRA tax free.
The details involved in maintaining and managing traditional and Roth IRAs can be very complex and depend on a person’s specific facts and circumstances. Whether you are the original owner or a beneficiary, we feel it is essential to consult a tax expert prior to making any type of contribution or distribution related to an IRA account.
Read our second part in this Roth IRA series to learn about specific strategies for contributing to a post-tax/Roth IRA account.
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