How to Make Roth IRAs Work for You

As a long-forgotten TV detective used to say, “Just the facts Ma’am, just the facts.” In any discussion about Roth IRAs there can be lots of what for’s and how come’s and what if’s. But here, we’re going to look at basic Roth IRA facts to see if a Roth makes sense for you.

The Roth IRA has been around since 1997. And as good a savings vehicle as it can be, only about 7.5% of the U.S. population has a Roth. The Roth IRA was intended to give people an additional tax-deferred way to save for retirement. You’re allowed to put money into a Roth IRA, although you don’t get a tax deduction for the contribution like you do with the Traditional IRA. The trade-off is that you get to withdraw money from your Roth tax-free any time after the age of 59 ½ and you’re never forced by the IRS to take required minimum distributions.

Annual Contribution Limit

In 2020, the maximum annual contribution to a Roth IRA is $6,000. If you’re 50 years old or older that number goes up to $7,000. The extra $1,000 is called a catch-up contribution. Keep in mind that’s the maximum contribution whether you contribute to a single IRA or break it up into multiple IRAs. If you contribute some to a Roth and some to a Traditional IRA the maximum is still $6,000 (or $7,000 if you’re eligible for the catchup).

To contribute you must have earned income, which is classified as salaries, wages, commissions, bonuses, self-employment, freelance and contract work. Your contribution may be limited by your income. For example, if you earn $10,000 you can make a Roth contribution of $6,000. If you earn $3,000 that is the maximum you can contribute.

If you have a non-working spouse, you can make the maximum contribution to both Roth IRAs as long as your earned income is enough. For example, if you earned $20,000 you can make the maximum total contribution to both Roths–$12,000 (or %14,000 if you’re eligible for the catch-up contribution). But if your earned income is $10,000, that is the maximum combined contribution you can make.

This is an added bonus. You can make Roth IRA contributions no matter your age aslong as you have earned income.

Income Limits

You can be prohibited from making a Roth IRA contribution if your income exceeds limits set by the IRS. For 2020:

If you file as single, you can make a full contribution as long as your income is not more than $124,000. Between $124,000 and $139,000 you can make a partial contribution. Above $139,000 contributions are not allowed.

If you’re married filing jointly you can make a full contribution if your income does not exceed $196,000. You can make a partial contribution if your income is between $196,000 and $206,000. Above that no contribution is allowed.

However, qualifying to make Roth IRA contributions is based on modified adjusted gross income (MAGI). That means if you make tax-deductible contributions to an employer-sponsored retirement plan, those contributions reduce your MAGI and may reduce it enough to get you into the allowable income range to make a Roth contribution.

Another possibility is a Backdoor Roth IRA. You make a full contribution to a Traditional IRA, then immediately do a Roth Conversion, moving the money from your Traditional to your Roth IRA. It can be a little tricky, so it’s advisable to have your accountant or CPA help you make sure everything is done correctly and you stay in the good graces of the IRS.

Roth Withdrawals

Since contributions to Roth IRAs are not tax-deductible, you can withdraw them at any time free of income taxes and the 10% early withdrawal penalty. The earnings from your contributions is another matter. If you withdraw those before age 59 ½ and you’ve had the Roth for less than 5 years you’ll pay taxes and the penalty on the earnings. Once you’ve crossed the age threshold of 59 ½ everything can be withdrawn without taxes or penalties.

But keep this in mind. If the value of your Roth drops below your total contributions and you want to withdraw all the money, you’ll receive the net value of the account at that time, not the amount of your original contributions.

The other withdrawal benefit you have with Roth IRAs is the absence of Required Minimum Distributions. Unlike its cousin, the Traditional IRA with forced withdrawals beginning at age 72, the Roth IRA has no RMDs ever. Roth IRA withdrawals are strictly your choice on your time schedule.