While every investment account is different in their own way, few offer as many benefits and flexibility as the Roth IRA. The main benefit most people know about is the tax-free growth. You can receive an unlimited amount of dividends, interest and realized capital gains without owing taxes. After you become 59 ½ years old, you can take the money out tax free!
Those are the main benefits of Roth IRAs. Now, let’s take a closer look at some of the benefits you might not know exist…
1. Access Contributions Anytime
There are two components of a Roth IRA account: contributions and earnings. Contributions are the after-tax money you put into your account each year. Earnings are the growth from your investments.
Let’s say you contribute $6,000 and your account grows to $7,000. You are eligible to take the contributions ($6,000) out whenever you want penalty free. The earnings portion ($1,000 gain) is subject to a 10% penalty and taxes if you withdrawal it before age 59 ½.
Since you contribute to the Roth IRA with after-tax money to begin with, it gives you the ability to pull that money out anytime. The maximum annual contribution for 2022 is $6,000, or $7,000 if you are age 50 or older. (Income limits below)
2. Take Early Withdrawals Penalty Free
In certain situations, the IRS allows you to pull out earnings from your Roth IRA without any penalties. Here are some of the scenarios:
- First time home purchase (up to $10,000, spouse can contribute extra $10,000 from their IRA)
- Higher education expense
- Qualified expenses related to a birth or adoption.
- Permanent disability
- Unreimbursed medical expenses or health insurance if you’re unemployed.
- Substantially equal periodic payments.1
If you’re under age 59 ½ and your Roth IRA has been open five years or more, your earnings will not be subject to taxes or penalties in the scenarios above.
If you take withdrawals under age 59 ½ and before the account is five years old, the earnings may be able to avoid penalties but not taxes in the scenarios above.2
3. You Have Until Tax Day to Contribute
Did you max out your contribution for 2021? If not, you have until the tax deadline (April 15th, 2022) to max your contribution for the 2021 tax year.
4. Custodial Roth IRA
For those of you with kids, this is a great way to jumpstart their savings. With a custodial Roth IRA, you are in charge of the money until the minor becomes a legal adult (Age 18 in Illinois). Your kids need to have real income that is reported to the IRS. They cannot contribute more than they earn. Side jobs for cash do not count.
It’s common for people who own their business to employee their kids and begin funding their Roth. Regardless, if your child has any reportable income, you can use this strategy to build long term wealth.
5. Roth IRAs for Non-Working Spouse
Your spouse can contribute to an IRA even if they do not have any earned income. To qualify, the IRS requires that you earn enough so that both of you can contribute and you are below the income limits (see below).
6. Backdoor Roth IRA
If you earn too much, a backdoor Roth IRA lets you convert a traditional IRA to a Roth. The backdoor Roth IRA is also referred to as a Roth IRA conversion.
Keep in mind that this does not avoid taxes. When you transfer assets from a traditional IRA to a Roth IRA, you owe taxes in that year. For example, if the IRA has been funded solely with tax deductible contributions, the entire value of the transferred assets will be taxed.
This strategy is used by high income earners who earn above the amount allowed to contribute to Roth IRAs (Income limits below). Another opportunity is during retirement when you have little to no income and can take advantage of being in a low tax bracket.
At PMG Wealth Management, we use a software to calculate how much you can convert in any given tax year. Please consult with us or your tax professional to see if these strategies would make sense for you.
Bottom Line
If you are eligible, the Roth IRA can be an excellent tool for retirement savings. Having a tax-free savings account for retirement is great- especially if there are future tax increases. If you have any further questions, please don’t hesitate to reach out.
George Maroudas
847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor
Disclaimers and Sources:
1.Substantial equal periodic payments: If you need to make regular withdrawals from your IRA for a few years, the IRS allows you to do so penalty-free if you meet certain requirements. Basically, you withdraw the same amount—determined under one of three IRS pre-approved methods—each year for five years or until you turn 59½, whichever comes later.12 This is referred to as taking substantially equal periodic payments (SEPPs) from your IRA.
2. https://www.schwab.com/ira/roth-ira/withdrawal-rules
3. https://www.investopedia.com/articles/retirement/02/111202.asp
4. https://www.investopedia.com/how-to-set-up-a-backdoor-roth-ira-4584775
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A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions apply.
