So, what is it exactly? You know what a traditional IRA is, right? Well, the Roth IRA is a lot like that traditional version, but it’s engineered a little differently so you get the tax break later instead of now. Let us explain.
The maximum yearly contribution is the same as a plain-Jane IRA which is set at $5,500 for 2018; $6,500 if you’re 50 or over. Unlike a traditional IRA, contributions aren’t tax deductible now. The benefit you get, though, is that the withdrawals are tax-free later. Which has significant advantages.
The bad news for big earners is that, unlike a traditional IRA, not everyone is eligible for a Roth. It can also be a little complicated to figure out how much you can contribute each year—a sliding scale kicks in once your income reaches a certain threshold determined by the government each year. So once you get above the threshold, you can’t contribute the full $5,500. If you’re single, you must make less than $118,000 to fully contribute to a Roth IRA. You can contribute partially if you make between $118,000 and $133,000; after that you’re not eligible. If you’re married and filing jointly, you’ll have to make less than $186,000 for the full contribution, and you become ineligible to contribute if you make $196,000 or more.
What are the pros? First, those tax-free withdrawals—as long as you are older than 59½ and your Roth IRA is at least five years old—in retirement. That could lower your tax bracket in retirement because you won’t have to declare your annual Roth withdrawals. Second: There are no age limits. While you can’t contribute to a traditional IRA if you are over the age of 70½, you can keep putting the max into your Roth as long as you don’t exceed income requirements. Roth IRAs also don’t have required minimum distributions beginning at age 70½, unlike Traditional IRA’s. So you can keep growing your savings tax-free throughout your lifetime.
Is there anything to be careful about? If your income is elastic, or if you think you’ll start making more than the limit and have to change investment accounts, a Roth could make it more complicated to juggle tax liabilities in retirement. Keep in mind that while you can withdraw contributions made to your Roth IRA anytime, tax- and penalty-free, if you are under the age of 59½ and the account has been open for less than five years, you may have to pay taxes and penalties on earnings in your Roth IRA. Before making an early withdrawal, take a look at the IRS Website or ask an expert.