A Roth IRA is designed to help you save for retirement. It allows after-tax contributions in exchange for the potential for tax-free income in retirement. Generally speaking, if you think you might be in a higher tax bracket when you retire, a Roth IRA may be right for you.
If you have earned income, or your spouse has earned income and you file your taxes as married filing jointly, you can contribute at any age as long as your modified adjusted gross income (MAGI) falls below or within the limits. You can contribute 100% of your compensation – up to the annual contribution limit. Those age 50 and older can make additional catch-up contributions. These limits, however, are reduced by any amount contributed to a traditional IRA. You can contribute to a Roth IRA anytime during the year and up to your tax-filing deadline (generally April 15). Keep in mind that you must make contributions to your Roth IRA in cash, not with investments.
You can withdraw your contribution dollars at any time tax and
penalty free: You can also withdraw earnings tax and penalty free, as
long as you have owned a Roth IRA for at least five years and have reached age 59½. The five-year clock starts with the first contribution.
No Required Minimum Distributions (RMDs): Unlike a traditional IRA, a Roth IRA has no required minimum distributions (RMDs) when
you reach age 70½. You control when you want to withdraw money. If you don’t need the money in your Roth IRA for living expenses, you can leave it so that it can continue to potentially grow tax free.
Roth IRA Conversions
Everyone is eligible to convert tax-deferred IRAs (traditional, SEP or SIMPLE) to a Roth IRA. Converting allows for tax-free accumulation as well as tax-free withdrawals in retirement and for your heirs.
What are the benefits of converting to a Roth IRA?
- You can have tax-free income in retirement – which means you don’t have to worry as much about future income tax rates.
- There are no required minimum distributions (RMDs).
- You have access to the dollars you converted penalty-free before age 59½*.
- Conversions are allowed after age 70½.
- You can create a tax-free legacy for your heirs.
It’s important to note that your income tax liability on a conversion is based on the value of investments held in your IRA when you convert to a Roth IRA. The amount you convert will be included in your taxable income in the year you convert.
Converting your tax-deferred IRA to a Roth IRA is not an all-or-nothing decision — converting a portion of your IRA is also a strategy to consider. Earnings distributions from a Roth IRA may be subject to taxes and a 10% penalty if the account is less than five years old and the owner is under age 59½.
There are various factors that may play into your decision to convert, so keep your end goal in mind. A few key decision factors include the following:
Will you be able to afford the taxes due?
What is your tax rate now and in the future?
When do you need to make withdrawals?
Do you have a desire to leave a tax-free IRA to your heirs?
You have the option to “undo” your conversion.
If you convert to a Roth IRA and later need to undo it, you can. For example, if you convert and later discover that you are in a higher tax bracket than you anticipated, your tax bill for the conversion could be more than you planned for. You can then decide to undo the conversion. This process is called recharacterization. Keep in mind that there is a deadline associated with recharacterizing, so you need to make sure to complete the recharacterization in time. Conversions can be recharacterized up to Oct. 15 of the year following conversion.