8 little-known facts and benefits of Roth IRA savings

benefits of roth ira

Most Americans want to save for retirement, but most don't know how to start. Putting money into a savings account is ideal for short-term goals and emergency funds. But there are better investment vehicles for long-term savings. One investment vehicle that I've grown to love almost as much as much as I love In-N-Out Burger (key word: “almost”) is the Roth IRA.

I know Get Rich Slowly has covered the Roth IRA a lot in the past, but new readers might not be that familiar with it. Besides, even though you might think you know everything there is to know about Roth IRAs, here are some facts that might be new to you.

1. The Roth IRA Has Been Around the Block

Most people don't know that the Roth IRA is getting close to getting its driving permit, having been around for almost 14 years. It originally started with the Tax Relief Act of 1997, named after late Senator William Roth of Delaware.

After the Roth IRA conversion event of 2010, there was a further influx of Roth IRA contributions. Much can be attributed to this based on when the Roth IRA conversion was made available in 1998, allowing savers to to convert from a traditional IRA to a Roth IRA. During that time, 1.4 million taxpayers converted $39.3 billion in traditional IRAs to Roth IRAs.

Related >> Read whether it's better to have a traditional IRA or Roth IRA.

2. Contributions to Roth IRA Are Not Tax-Deductible

Unlike other retirement vehicles, such as the employee-sponsored 401(k), contributions to a Roth IRA are not tax-deductible. Contributions to your Roth IRA are made with after-tax dollars. This does not offer an immediate tax benefit compared to one that is recognized at the time of distribution. When you take a qualified distribution from your Roth IRA, you will never pay taxes on that money.

This allows you to have access to your contributions at any time. That's an attractive feature for those that want to save for retirement but are worried about having to pay a penalty if they need access to the money.

While you don't get a tax deduction, you may qualify for the Roth IRA savers credit. The downside of the credit is that if your adjusted gross income exceeds $27,750 filing single for the 2017 saver's credit for a credit rate of 50 percent of your contribution, you don't qualify. For people married and filing jointly, the adjusted gross income limit is $37,000.

3. You Must Meet Eligibility Requirements to Contribute to a Roth IRA

As the Roth IRA gains popularity among retirement savers, many people fail to understand that not everyone will be able to contribute to this type of account. In order to contribute to a Roth IRA, you must fall below the established income thresholds set forth by the IRS each year. The cut-off limits (otherwise known as phase-out limits) for 2017 are $118,000 to contribute up to the limit and $132,999 to contribute a reduced amount for single filers. The limit is $186,000 for married couples filing jointly to contribute up to the limit and $195,999 to contribute a reduced amount.

If your income falls beneath the threshold for your filing status for the year, you must also make contributions from taxable compensation. This means individuals cannot use rental property payments, royalties or other non-taxable compensation to make contributions to a Roth IRA.

4. You May Be Able to Convert Other Retirement Accounts to a Roth IRA

Since 2010, there are new conversion rules that apply to the transferring of funds from a traditional IRA or 401(k) to a Roth IRA. When you convert from a tax-deferred retirement account to a tax-free retirement account, you'll potentially see many benefits long term. It's important to remember that the IRS isn't going to forget about the taxation of this money. Whatever amount you transfer to the Roth IRA will be tacked on to your earned income (and taxed at your current rate) for the year of the conversion.

5. Benefits of Roth IRA Savings Can Help Meet Other Financial Goals

Usually, experts recommend that retirement vehicles be used solely for retirement purposes. However, out of all the retirement accounts on the market, the Roth IRA can be used for other goals.

Since you have already paid taxes on your contributions, you are able to enjoy tax-free distributions of those contributions (but not the earnings) before you reach retirement age. As long as all distribution requirements have been met, you may access that money for other things. These include a down payment on a home or college tuition. Often times I will meet with young parents who are very ambitious about saving for the kids' college. However, they are barely saving anything for their own retirement. In these situations, I often suggest the Roth IRA as a viable substitute.

6. Roth IRA Distributions Don't Contribute to Taxable Earnings

One of the most attractive features of the Roth IRA is that, when you start taking distributions, you don't have to worry about them contributing to your taxable income. This is because Roth IRA contributions grow in your account tax free since you're contributing after-tax dollars. With a traditional IRA, you make a contribution with pre-tax dollars. As a result, you end up with a deduction. A traditional IRA contribution lowers your taxable income.

This is not the case with a Roth IRA. You get no tax benefit immediately for making a contribution to your Roth retirement account. You pay taxes on your income, and then you make your contribution. However, because you have already paid taxes on the money you use, you won't be taxed on it again. Your money grows tax free. For those who think that they'll be in a higher tax bracket or that tax rates will go up by the time they retire, this can be an advantage. You pay taxes at your current, lower rate. And then when you take your distributions, you avoid paying taxes at your future higher rate.

7. There is a Five-Year Rule for Roth IRA Withdrawals

It is possible to withdraw money that you have contributed to your Roth IRA at any time, tax- and penalty-free, as long as you meet the distribution requirements. However, if you want to withdraw the earnings from your Roth IRA, it is important to realize that you must have the account for at least five years. The clock starts ticking from the first day of the tax year in which you designate your contribution. So, if you open your Roth IRA in September of 2016 and make your initial contribution, you can make withdrawals of your earnings starting January 1, 2021.

This also works if you open your Roth IRA before April 15 and designate the contribution for the previous year. For example, you can open a Roth IRA on April 10, 2017, and designate 2016 as the year for your contribution. The clock starts ticking on January 1, 2016, even though you opened your IRA in April.

The five-year rule also applies to conversions. You cannot withdraw the converted amount in your Roth IRA until five years have passed.

8. There are No Required Minimum Distributions During the Life of the Roth IRA Owner

For some folks, required minimum distributions (RMDs) are a big problem with retirement accounts. This is a minimum amount that the IRS says you have to withdraw from your retirement account each year once you reach a certain age. With some accounts, like 401(k)s, this can be disheartening. Since RMD can add to taxable income, this can possibly put you in a higher tax bracket.

However, with a Roth IRA, there are no RMDs. The owner never has to withdraw money if he or she doesn't want to. It is important to note that this privilege disappears upon the death of a Roth IRA owner. Heirs to the Roth IRA must take RMDs (but the RMDs are still tax-free). Inheriting a Roth IRA is very similar to receiving the proceeds of a paid-out life insurance policy.

The Bottom Line for Roth IRAs

The Roth IRA is growing in popularity because it offers many benefits without several of the drawbacks associated with other retirement accounts. In addition, the Roth IRA allows for contributions for the remainder of your life. This is unlike the traditional IRA that restricts you from contributing after age 70-1/2.

A Roth IRA can be a great savings tool. Just make sure you understand the Roth IRA rules that come with it, and be careful to adhere to them.

More about...Taxes, Investing, Retirement

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SB @ One Cent At A Time
SB @ One Cent At A Time
8 years ago

Money you roll over from a 401(k) to an IRA can be a traditional IRA or a Roth IRA, depending on whether you pay tax at the time of rollover. If you simply move the 401(k) money to IRA without paying taxes on it, then it is a traditional IRA.

If all of your 401(k) contributions had been pre-tax, then you’ll have a big tax bill when you convert to a Roth IRA.

What do you suggest people should do to optimize return on 401(k) to Roth IRA conversion?

Jeff Rose
Jeff Rose
8 years ago

Unfortunately there’s not a lot you can do other than not make a lot of money. Obviously, that’s not very cool. 🙂

If you are a business owner and you have a net capital loss, that gives you the option to greatly reduce your tax liability.

Eric J. Nisall
Eric J. Nisall
8 years ago

Another way to minimize the tax burden is to pick and choose when you roll over certain portions. If someone loses their job or has a significant reduction in income that would be an ideal time to do a conversion (full or portion) since they can take advantage of being in the lower tax bracket.

STRONGside
STRONGside
8 years ago

I have also used the ROTH IRA successfully as a down payment on our first home. i was able to withdraw $10,000 and put that towards our down payment.

I believe you can also withdraw penalty free for education expenses as well.

Mike Piper
Mike Piper
8 years ago
Reply to  STRONGside

This is correct (assuming the education expenses are “qualified higher education expenses”). In addition, these are both acceptable ways to get money out of a traditional IRA prior to age 59.5 without paying the 10% penalty.

Jeff Rose
Jeff Rose
8 years ago
Reply to  STRONGside

Do remember that although you avoid the 10% penalty, however; keep in mind that you’ll still be on the hook for any income tax liability generated by an early withdrawal.

William
William
8 years ago

For those planning for an early retirement, being able to withdraw the principle could be incredibly helpful. My plan calls for using that principle as living expenses for several years, until the other revenue streams kick in.

Mike Piper
Mike Piper
8 years ago
Reply to  William

Via the 72(t) rules it’s possible to get money out of a traditional IRA prior to age 59.5 without paying a penalty.

That said, it’s tricky business and best done with the help of a tax professional.

William
William
8 years ago
Reply to  Mike Piper

Right, Mike.

We’re planning on doing the 82(t) withdraws for our 401(k) plans as well. We’ll see if that works or not.

Mike Piper
Mike Piper
8 years ago
Reply to  William

This article may be helpful:

http://www.irs.gov/retirement/sponsor/article/0,,id=151926,00.html

You’ll see that the “series of substantially equal periodic payments” appears there as one of the exceptions.

Note also, however, that you’re allowed penalty-free distributions from a 401(k) starting at age 55 (rather than 59.5) if your separation from service occurred in a year in which you turned 55 (or older) — the advantage to this over the SEPP route being that you’re not locked in once you start.

Jeff Rose
Jeff Rose
8 years ago
Reply to  William

I’m personally not a big fan of 72(t), especially if you can avoid it. Mike brings up a good point about early distribution rules starting at 55.

I’ve had clients that have locked in 72(t) during the last 5 years and you can imagine how chaotic that has been with the ups and downs of the market. Locking yourself in for any extended period of time, can leave you vulnerable, IMHO.

Kent+@+The+Financial+Philosopher
[email protected]+The+Financial+Philosopher
8 years ago

Also, it is possible that income tax rates will either be the same or higher (even after considering a smaller need for income) in retirement for those retiring 10, 20 or 30 years from now. This diminishes the value of the traditional IRA.

I’m a CFP and I don’t think I’ll ever contribute to a traditional IRA again in my lifetime. I use ROTH.

My ROTH IRA is designated as many things — retirement account, emergency fund, education savings and more…

fantasma
fantasma
8 years ago

Is maxing out the Roth IRA AT 5,000.00 per year enough for Retirement?

For me its not, its best to have both pre-tax and after tax income streams in retirement.

hiyaE
hiyaE
8 years ago

How about ROTH 401K? Can this be covered in a followup post.

Robert
Robert
8 years ago
Reply to  hiyaE

Yeah that would be great. I have a Roth 401k at work and am a bit confused. Are employer contributions actually part of the Roth 401k or are the held in something like at Traditional 401k?

Tom
Tom
8 years ago
Reply to  Robert

They’re in your Roth 401k, but are taxable upon withdrawal. Roth 401ks seem like they’re a bit of a logistical nightmare because you account for a portion of it to be taxed and a portion to be untaxed.

Courtney
Courtney
8 years ago
Reply to  Robert

I think it might depend on the company? My husband has the option of a regular 401K AND a Roth 401K, but in order to have the Roth 401K he must also have a regular 401K and that’s where the company contributions go regardless of how he divvies up his own contributions.

Doug
Doug
8 years ago
Reply to  Courtney

I am the Owner of a small business where my wife is the only other employee. We use a ROTH 401K and a Traditional 401K. We make post-tax contributions up to the 401K limit and then our company can match up to 25% of our salary into the traditional 401K. The greatest advantage of this over the ROTH IRA is there is no income limit. With the IRA you must make under a certain amount. Anyone can participate in the ROTH 401K. We found a very good provider to help us set ours up. They charge 1/2 percent per year… Read more »

Mike Piper
Mike Piper
8 years ago
Reply to  Robert

The way Courtney describes it working above is correct. Employer matching contributions are always pre-tax.

http://www.irs.gov/retirement/article/0,,id=152956,00.html#10

Personal Finance Source
Personal Finance Source
8 years ago

I like the idea of being able to pull out the principal without penalty. Any chance the government in thier need for more and more money could make withdrawals taxable in the future? I would also be interested in Roth 401k information as this is what I contribute to at my employer. Thanks for the great info!

Retireby53
Retireby53
8 years ago

I took a class on tax policy last semester for my Masters of Taxation degree and did my research paper on Roth IRA versus Traditional IRA. My research showed that the future taxability of the Roth IRA is uncertain. There could possibly be a tax administration in the future that could tweak the wording of the code so that maybe part of the “tax free” distribution could be taxable in the future. With that being said and the additional research that I did, I am sticking to traditional IRA and taking the tax deduction now. The future of the code… Read more »

Ross Williams
Ross Williams
4 years ago
Reply to  Retireby53

You don’t get a “tax break now” with a traditional IRA, you get a tax deferral which is certainly subject to changes in the tax code. The only way you come out ahead is if you are paying higher taxes now than you will in the future. Traditional IRA’s make sense for high earners who expect their income, including their IRA withdrawals, to decline in retirement. Everyone else should be putting money in Roth type accounts. The most likely change to effect IRA’s is a switch to some sort of sales tax, like a value added tax, that replaces income… Read more »

Dan
Dan
8 years ago

The Roth 401(k) has a lot of the same tax treatment of an IRA, plus the benefit of significantly higher contribution limits, but there are two major factors to consider. 1) The crappy investment options your 401(k) might have. 2) The PLAN (not the IRS tax code) may not let you take distributions. This is probably to keep more money under their management. I would definitely go Roth IRA first, and then any extra after-tax contributions to a Roth 401(k). I tend to split, for now, pretty evenly between traditional and Roth. In my opinion, despite what Obama might be… Read more »

Jeff Rose
Jeff Rose
8 years ago
Reply to  Dan

@ Dan One other thing to consider with your existing retirement plan is not only when the investment options suck, but also if there are surrender charges involved. For example, I recently had a client that left her job and was wanting to roll her retirement account (she had a Simple IRA not a 401k)into a Traditional IRA. She had been working there for almost 7 or 8 years. Unfortunately, her employer had used one of those big bad insurance companies as their retirement plan provider and she was in some sort of annuity product. In a nutshell, she had… Read more »

20's Finances
20's Finances
8 years ago

I love the ROTH IRA. I didn’t know about the ROTH IRA savers credit, but will check it out. Thanks for the tips.

Mike Piper
Mike Piper
8 years ago

IMO, over-Rothing is one of the biggest mistakes many investors make. One thing I hear over and over from recent retirees is that they dramatically overestimated their retirement tax bracket.

My rule of thumb is that unless you:
a) need access to the money well before age 59.5,
b) expect to have a pension in retirement,
c) expect to continue working in retirement, or
d) already have a giant pile of tax-deferred money

…it’s better to prioritize tax-deferred saving over Roth saving.

Courtney
Courtney
8 years ago
Reply to  Mike Piper

Or e) If you have no clue what future tax rates will be (the younger you are, the more true this is) it’s probably a good idea to diversify your investments tax-wise and have some money in each.

Mike Piper
Mike Piper
8 years ago
Reply to  Courtney

Courtney: Excellent point.

When I said “prioritize tax-deferred saving,” I hadn’t meant to do it to the complete exclusion of Roth saving, but I can see how it might have come across that way.

Courtney
Courtney
8 years ago
Reply to  Mike Piper

Thanks for the clarification, Mike. I had read it as “put money into your 401K, and then if you still have money left over, put some into a Roth.” Across all our retirement accounts we’re about 80-20 between the 401Ks and the Roths at the moment, but if you only look at my retirement accounts it’s 40-60 in favor of the Roth because I’ve only had access to a 401K in the last two years.

Dan
Dan
8 years ago
Reply to  Mike Piper

I guess, taking this “roth” discussion one step further, we should maybe examine the taxpayer’s goals AFTER age 75-80. Once you hit 80, your RMD’s start to get pretty darn big, and by 90, they’re huge. This could very well push someone into much higher tax brackets in later retirement than they’d otherwise want to be. Further, any roth or IRA transferred to your kids has to be distributed to them over their lifetime given RMD rules, and depending on their tax situations, you might be handing them an IRA with a high “implied tax liability” attached to it.

Holly
Holly
8 years ago
Reply to  Mike Piper

Why do you include having a pension in your list of exceptions on why to sign up for a Roth? Does it have something to do w/being ineligible for tax deductions w/a traditional IRA?

Mike Piper
Mike Piper
8 years ago
Reply to  Holly

All else being equal, having a pension will put you in a higher tax bracket in retirement than somebody without one.

There are plenty of exceptions, but the general rule for Roth vs traditional is that if you expect to be in a higher tax bracket when you withdraw the money than you’re in when you contribute the money, a Roth is a better choice.

Debbie M
Debbie M
8 years ago
Reply to  Mike Piper

Pensions are taxable. So a Roth lets you diversify and have some of your money pre-taxed. I don’t know about other people, but if I were getting my (predicted) pension right now, I would be in the 15% tax bracket. I can’t imagine getting enough raises in the next 3 years before I retire to even get my full pay above the 15% bracket (after deductions), let alone my future pension. I can, however, imagine tax rates going up. Look at the history of tax rates. And look at our national debt. I feel pretty sure taxes are not going… Read more »

Steve
Steve
8 years ago
Reply to  Mike Piper

I totally agree. I suspect it is due to the psychological bias towards “free” things. Most people will NOT be in a higher tax bracket when they retire.

There is also
f) Are already maxing out tax-deferred retirement accounts.

Holly
Holly
8 years ago
Reply to  Steve

@ Steve,

See Mike’s original comment: ‘d’, already have enough tax-deferred savings

Steve
Steve
8 years ago
Reply to  Holly

Mike’s (d) is “already have a giant pile of tax-deferred money” which is not exactly the same thing, though it is similar (e.g. if you may out tax-deferred accounts over time, you will end up with the giant pile of tax-deferred money).

Ross Williams
Ross Williams
4 years ago
Reply to  Mike Piper

I think it is important to remember that every dollar you take out of your tax deferred savings raises your income by that amount for tax purposes. That includes raising your tax bracket and the amount of taxes you will have to pay on your social security. So the more you take out of a traditional IRA, the higher your taxes are likely to be. Roth withdrawals don’t count at all for tax purposes. Most people under 40 should be using a Roth. They are likely in a relatively low tax bracket, with deductions for kids and mortgage interest. As… Read more »

Dan
Dan
8 years ago

I think for MOST people, putting 2/3 into IRA and 1/3 into a Roth as a “simple rule,” and modifying that as they get closer to retirement and have a clearer view of their net worth, cash flows, and tax laws, they’ll be in a great spot. My only hesitation with over-doing the Roth is the realization that when my house is paid off, I’m no longer having to set aside savings every month, my SS is only partially taxable, and my wife and I aren’t paying 7.6% of our gross income into FICA & medicare, I’m likely to be… Read more »

Steve
Steve
8 years ago
Reply to  Dan

2/3rds tax deferred is my rule of thumb as well.

abby
abby
8 years ago

This was really helpful!

Random+Anonymous
Random+Anonymous
8 years ago

Past performance is no guarantee of future results. If anyone has a Healthcare Savings Account, you know how easily the rules governing tax sensitive accounts can change. It is easy to see the attempts to eliminate these accounts included in the health care reform act. I have no confidence that the government will be able to keep the promise not to tax earnings on Roth IRA’s. I am contributing some retirement funds through a Roth, but most contributions are tax deferred through a 401(k). I know the tax benefit I am receiving today (via 401(k)), but am not certain the… Read more »

Steve
Steve
8 years ago

The change to HSA’s was trivial. How much did you really spend on OTC stuff? I don’t take that as proof that the government is going to change the rules at a whim. Roth accounts are not some government conspiracy to tax us now and then again later.

I suspect the reason Roths were invented was so that the politicians could get tax revenue this year instead of some future year. (Getting it this year means they can spend it and get themselves reelected.)

Random+Anonymous
Random+Anonymous
8 years ago
Reply to  Steve

I agree that the OTC change was trivial. In physician co-pays, family eye care, prescription copays, orthodontics, etc. I spent several thousand in medical care each year. Since HSA accounts can only be paired with high deductible plans, I paid for medical care almost entirely out of pocket for several years. My employer changed insurance back to a more traditional PPO plan and offers an FSA. I am no longer sure about HSA accounts, but FSA accounts have a scheduled reduction of the contribution limit from $5000 to $2000 starting in 2013. This is the significant change to which I… Read more »

Steve
Steve
8 years ago

The FSA change may annoy you, however it is not retroactive. Of course the rules may change in the future; they change all the time. The Roth didn’t even exist as an option 15 years ago. 25 years ago credit card interest was tax deductible. That’s not the same thing as the government not living up to it’s promises. I am not saying it can’t happen, just that your example doesn’t prove it. I don’t trust the government, per se, however I model it as a collection of individuals politicians looking to get reelected. As such I am dubious that… Read more »

Debbie M
Debbie M
8 years ago

Exactly. All the money you put in there before is still tax free. I can see people phasing out the Roth IRA, but I really don’t think the money you’ve got in there will be subject to different rules later. And they’ve already taxed your contributions–I really don’t think they’ll double tax you. EXCEPT by making a national sales tax. And with a national sales tax, you’d pay that regardless of which kind of IRA/401K you were withdrawing your money from. Also, my experience has been that when rules change for retirees, people who are already retired (or close to… Read more »

Corinne
Corinne
8 years ago

I”ve been mulling over this, and it seems to me that contributing to a Roth when you are first starting out in your career and in a low tax bracket and then transitioning to 401k when your income increases might get the best balance of both vehicles. I would hate to pay a higher tax rate on some of that Roth money if my tax bracket is higher right now than it would be in retirement.

Brian
Brian
8 years ago
Reply to  Corinne

Hopefully, if you are in a high tax bracket, you are able to max out both the 401k and the Roth IRA. If putting $16,500 in a 401k and $5,000 in a Roth is not something you can do, then you are probably not in a high tax bracket anyway.

Jonathan
Jonathan
8 years ago

For “little known” facts, a lot of these seem to be common knowledge to me. A truly little-known fact that was not mentioned, and applies to both Roth and regular IRAs, is that they can be invested in pretty much ANYTHING. In fact, the laws only list the few things you CAN’T invest in, such as collectible artwork or coins, personal residences, and a few others. However, you can use a Roth IRA to invest in real estate, notes, private equity, or pretty much anything else through a “self-directed” IRA.

Des
Des
8 years ago
Reply to  Jonathan

I agree with this – the title is a misnomer. I always feel kinda tricked when authors come up with catchy titles, then just provide the same well-known information over again. I stopped reading CNN daily for that reason.

I also agree that self-directed IRAs and the 72(t) rule are lesser-known IRA facets that would have been prime material for a post with this title.

Tom
Tom
8 years ago
Reply to  Jonathan

Also agree that many of these are pretty widely known. I’d have like to have read more about the Roth IRA as an inheritance vehicle. (See “The Smartest Retirement Book You’ll Ever Read” – the author advocates holding on to your Roth as long as possible because of the tax-free RMDs for heirs combined with compound interest)

Steve
Steve
8 years ago
Reply to  Jonathan

I agree. A Roth IRA is taxed now but not when you withdraw? STOP THE PRESSES!

Chris Schneider
Chris Schneider
8 years ago

One risk associated with Roth IRAs: A national sales tax. I doubt that the specific tax benefits that Roths get will change (tax free withdrawls), but over the next 20-30 years, it’s easy to guess that there’s at least a chance that a new tax system will get put into place, where you pay taxes at time of purchase. In that context, you’d pull out your earnings tax free, then immediately pay taxes on them when you go to actually spend. Effectively ending up with that money getting double taxed (once when put in, once when spent) — meaning that… Read more »

Tom
Tom
8 years ago

A national sales tax is not an income tax, but I get your point and agree about tax diversification.

Chris Schneider
Chris Schneider
8 years ago
Reply to  Tom

Right – it’s not an income tax, but over the time frame of 20-30 years, the bulk of taxes could easily shift away from income tax, into something else like a VAT, or Sales tax, which would hurt the benefits that Roth accounts propose.

So yeah, split savings across different types of tax advantaged accounts.

Ross Williams
Ross Williams
4 years ago

You will have to pay VAT taxes on purchases with the money taken out of traditional IRA’s as well. Traditional IRA’s have an advantage only if you don’t have to pay any of the deferred taxes. That seems very unlikely.

Jen
Jen
8 years ago

Question about the income limits for contributing: is this gross income or taxable income (for married filing jointly). This always stumps me when people discuss tax policy (such as “raising taxes on those making more than $250K/year). There’s a big difference between what you earn as a salary and taxable income. Regarding what others have said about the “permanence” of the tax-free withdrawal: I’ve already paid taxes on the money I contributed to the Roth. I think there would definitely be a challenge if anyone in Congress decided that taxing upon withdrawal was a good idea. Not saying it won’t… Read more »

Courtney
Courtney
8 years ago
Reply to  Jen

It’s not gross income or taxable income (AGI), but something weird called ‘Modified Adjusted Gross Income’ (MAGI). You have to take your AGI and add back certain things.

Mike Piper
Mike Piper
8 years ago
Reply to  Jen

With regard to Roth contributions, it’s “modified adjusted gross income (MAGI),” which is neither gross income nor taxable income.* In this particular case, MAGI means adjusted gross income (the bottom line of the first page of your 1040), with a few adjustments — adding back any student loan interest deduction, any deduction for a traditional IRA contribution, any tuition and fees deduction, and a few other less common ones. Follow this link then scroll down a bit for the complete explanation: http://www.irs.gov/publications/p590/ch02.html#en_US_2010_publink1000230988 *In fact, depending on what particular tax topic we’re talking about, the definition of “modified adjusted gross income”… Read more »

Megan E.
Megan E.
8 years ago

I love my Roth IRA and right now, as a grad student, my tax rate is probably the lowest it’ll ever be so it’s worth investing in a Roth. If we had more money, I’d also invest in the TIAA-CERF accounts open to us, but alas, funds only go so far. I am disappointed that the government excludes students from getting the saver’s credit – that seems to be counterintuitive since students (at least graduate students) need all the extra help they can get and are at the best point in their lives to save! I do hope the Roth… Read more »

Tim
Tim
8 years ago
Reply to  Megan E.

Make sure your income is “earned income.” My fellowship isn’t considered earned income, which is required to be able to contribute to any sort of IRA. An easy way of figuring out if your income is considered “earned” or not is if you pay Social Security taxes — if you do, it’s probably earned income. If you don’t, it’s definitely not and you’re not eligible to use that money for an IRA.

PawPrint
PawPrint
8 years ago
Reply to  Tim

If you’re married and file jointly with a working spouse, you can contribute to your own Roth IRA. The income requirements are the same.

Tim
Tim
8 years ago
Reply to  PawPrint

While true, I don’t think many graduate students are married to a working spouse and filing jointly. And many of those who are are married to other students.

kate
kate
8 years ago
Reply to  Tim

I’m not saying that you are wrong about your own personal situation with the fellowship, but I would like to present a situation that seems very similar on the surface but was actually very different, tax-wise. I received a stipend as a graduate student, and it WAS considered earned income for Roth IRA contribution purposes — I actually asked a financial planner about this, and she told me that the fact that it was reported on a W2 (not some other form) was what made it “earned income.” It is not about whether social security payroll taxes are withheld. There… Read more »

Tim
Tim
8 years ago
Reply to  kate

You’re right, whether or not you get a W-2 is a better rule of thumb. As for me, I don’t get one, and thus none of my fellowship is considered earned income. What’s fascinating to me is that at my institution, how graduate students are paid depends on where the funds to pay them come from. If the money comes from the NIH, it’s considered earned income (and they have to pay Social Security taxes), but other funding sources don’t require this. My fellowship previously came from a private foundation and now from the state of California, but sadly neither… Read more »

Tim
Tim
8 years ago
Reply to  kate

Oh, and you’re right that there are certain groups (usually public employees of certain states) that don’t pay into Social Security, but instead pay into their own pension system. But those groups opted out of Social Security, rather than not being eligible for social security.

Either way, my first rule of thumb was just talking about students. I’m not sure I can think of any “real jobs” that aren’t considered earned income.

Golfing Girl
Golfing Girl
8 years ago

I would certainly hope the American people would never stand for Roths being taxed in the future, as double taxation is illegal as far as I know.

I love the Roth and look at it not only as a source of retirement funds, but as college savings and emergency fund savings as well (it would have to be a SEVERE emergency for me to touch it though). This will be the first year we haven’t maxed out our Roths and I’m a little sad. But being a stay at home mom has been worth it.

Steve
Steve
8 years ago
Reply to  Golfing Girl

There is no law against double taxation. That said, enough voters are aware of Roths that I think any attempt to tax them would be political suicide.

Chris Schneider
Chris Schneider
8 years ago
Reply to  Steve

There are lots of types of taxes. I don’t think a national sales tax would get the kind of anger (specific to roth) that a “ohh, pay income tax now” decision would. Even though in the end, you’re paying taxes on “tax free” money.

Steve
Steve
8 years ago

I don’t think people would fall for it, though. It is possible that there could be enough voters without Roth’s at some point in the future, that they could get away with it (vote to take money away from those “rich” people). On the other hand I think that between the allure of the word “free”, and poorly considered advice such as the above and Tent Hamm’s neverending beating of the Roth drum, many people do have Roths (including many for whom it is inappropriate – including some people commenting on this thread!) It’s also possible that some future government… Read more »

Ross Williams, Grand Rapids MN
Ross Williams, Grand Rapids MN
8 years ago

I think one issue not raised here is whether you are maxing out your IRA/Roth contributions. If you are, then the same amount in the Roth account is going to provide you more money in retirement. In a traditional IRA (or 401k) a portion of the money you save actually belongs to Uncle Sam. As has been noted, the government will get its share, including earnings, based on your tax rate when you take it out. So $5000 in a Roth will yield $5000. $5000 in a IRA will only yield $4250 if your marginal tax rate during retirement is… Read more »

Jeff Rose
Jeff Rose
8 years ago

@ Ross

Great follow up info. Thanks for providing!

Elayne
Elayne
8 years ago

I’m about to go into my company’s 403b plan. I’ve been here a year and my company is contributing 5% if I contribute at least 5%. My brother is a financial planner and he said that there are more investment options with traditional IRAs. I’ve decided to go with the traditional because I need the tax savings now and I don’t make that much. My situation is a little different in that I’m 54 and don’t have any retirement savings. I used to but to make a long story short s**t happens.

Dan
Dan
8 years ago
Reply to  Elayne

Elayne!!!

MAKE SURE you contribute up to the match… it’s too good to pass up, regardless of the investment options, or lack thereof.

Your brother wasn’t suggesting you ignore the 403b was he? Yes, IRA’s have more options, which is good, but a match can’t be passed up.

Elayne
Elayne
8 years ago
Reply to  Dan

Thanks Dan. Yes I am definately going to contribute %5. Once I get a part-time job I’ll be putting in more. My goal is to be able to put in the max for ppl over 50. I may not be able to do it this tax year but def from the next year.

Jeff Rose
Jeff Rose
8 years ago
Reply to  Elayne

@ Elaine

That actually might be a good thing to pass on the 403b. With the change in 403b regs a few years ago, we’ve seen a lot of mutual fund providers dropping out and mostly insurance companies with annuity products being the only options. In one such case, a prospect I was talking (who is similar age to you) was duped into one of these and had a 10 year contract period attached to it. Insane!

Make sure to read the fine print.

Elayne
Elayne
8 years ago
Reply to  Jeff Rose

Thanks for the info Jeff. I work for a university so they only offer 403b. I’ll be going with Fidelity.

Chad
Chad
8 years ago

The savers credit is something I didn’t know about, might just qualify for the 10% bracket. The caveat is that my wife is a full time college student, and if we don’t file jointly I would probably make too much on my own to qualify as head of household. That’s also interesting what Ross said about not being able to make contributions in the same year you withdraw contributions. I’m still seriously considering moving most of my emergency fund into my Roths this year to max them out though. .99% in an Ally Money Market account is just too much… Read more »

krantcents
krantcents
8 years ago

Roth IRAs may be more valuable in the short term than when you retire. You can use it to save to buy a house and not be penalized for withdrawal.

Courtney
Courtney
8 years ago
Reply to  krantcents

At $5K per year, you’re not going to get very far on a down payment in the “short term” – we’re saving about five times that much a year in a taxable account for 20% down in a few years.

krantcents
krantcents
8 years ago
Reply to  Courtney

What I meant was closer horizon than retirement. In some cases that could be ten years.

Paul
Paul
8 years ago

This is great info. The ROTH is a great way to diversify current and future taxes along with a traditional 401k.

Kathy+F
Kathy+F
8 years ago

“If your income falls beneath the threshold for your filing status for the year, you must also make contributions from taxable compensation. This means individuals can not use rental property payments, royalties, or other non-taxable compensation to make contributions to a Roth IRA. ” I am confused by this. I thought you could only contribute to a Roth IRA if you received earned income like wages. Income from pensions, interest, dividends etc did not qualify. I know I can convert some of my 401(k) money when I retire to Roth IRA, but since I will be retired I am no… Read more »

LC
LC
8 years ago

Can you contribute the max $ to receive company match to a 401K and also contribute up to the limits for a Traditional IRA and a Roth IRA ($16,500 and $5,000, respectively)? Or is there a maximum you can contribute to any combination of these retirement accounts (ie. Would you have to deduct the amount you contribute to the 401K from the max you can contribute to the traditional IRA)?

Jeff Rose
Jeff Rose
8 years ago
Reply to  LC

@LC You can definitely contribute to both. What will start to affect how much you you either contribute or get a tax deduction for is your income limits. For example, if you exceed the income threshold (see above), then you won’t be able to contribute to the Roth. Keep in mind, however, that by contributing to your 401k, you are actually reducing your taxable income that might make you able to contribute to a Roth IRA. (I was actually able to do this a few years ago). Regarding Traditional IRA’s, you can always contribute the maximum to them BUT…if you… Read more »

Mike Piper
Mike Piper
8 years ago
Reply to  LC

Provided you meet the income requirements, you can contribute $16,500 to a 401(k) and $5,000 to a Roth IRA (or $5,000 to a traditional IRA).

LC
LC
8 years ago
Reply to  Mike Piper

Ah, it’s either/or/split on the IRAs and the 401K has it’s own limit. That’s where I was mistaken. Thanks for clarifying!

Mark
Mark
8 years ago

My question is what is the best type of investment for ROTH IRA?

ETFs (if yes what kind?)
Dividend Stocks
Individual Stocks
etc.

If I can narrow down which type of investment is best then I’d be able to do more research

Ross Williams, Grand Rapids MN
Ross Williams, Grand Rapids MN
8 years ago

Decisions about investments in a Roth are the same as any other investment. What is your timeframe for spending the money. The term “emergency fund” is used in a lot of different ways. Some people see it as sort of like life insurance, used only in the extreme. Others see it more like car insurance, a fund that gets used for “emergencies” like replacing the furnace. And others see it as more like health insurance, used regularly for small emergencies. There is a built in conflict between the investment strategy for retirement (in 20+ years) and one that is appropriate… Read more »

Joe
Joe
8 years ago

The one thing that scares me about Roth IRAs is the risk of the government going to a value added or fair tax (either fully or in addition to the income tax). If that happens, my earnings will get taxed twice. Since I’m only 26 years old…a lot can happen between now and when I retire. Who know what taxes will be in 40 years or how they will be collected. With a traditional IRA I get my tax benefit now, which can be invested and compounded. The gap between the tax benefit of a Roth and a traditional isn’t… Read more »

Debbie M
Debbie M
8 years ago
Reply to  Joe

I don’t see them adding a VAT and then dropping the income tax. In which case, people with regular IRAs would also be double-taxed (once when they withdraw the money and again when they spend the money).

Manish
Manish
8 years ago

William Roth??
I always believed it was named after JD Roth!

Money Reasons
Money Reasons
8 years ago

Great points, I’m always correcting misinformation (especially this point: The Roth IRA can be used for other savings goals) that I hear at work. Ironically, I work at a financial firm, so I’m always shocked to hear such misinformation.

Ross Williams, Grand Rapids MN
Ross Williams, Grand Rapids MN
8 years ago

I think it is important to remember that the government is no more likely to act in a way that adversely impacts having a Roth IRA than it is to adversely effect traditional IRA’s. For instance, as someone pointed out, a VAT would apply to money spent from those or any other source. I think hardly anyone under 30 should be saving for retirement unless their employer is matching their money. But a Roth is a way to save money that you may or may not need without tying it up until age 59. If it turns out you never… Read more »

Lahmacun
Lahmacun
8 years ago

I am currently unemployed but do not receive unemployment or any other financial assitance, as I am currently being supported by my spouse. I have some money in savings that was already taxed as income when I first earned it in years I was working. Can I contribute to my Roth IRA from my savings this year, even though I didn’t earn the money this year?

Ross Williams, Grand Rapids MN
Ross Williams, Grand Rapids MN
8 years ago
Reply to  Lahmacun

You can’t contribute to a Roth IRA from savings. But your spouse can make a contribution for you, assuming they have enough earned income this year, and you can take the money out of your savings to make the contribution.

Alan
Alan
8 years ago

How to convert 401k into Roth IRA? Is it worth it? I recently graduated college and have a small Roth 401k account with my company. My company participate in a ROTH 401k matching program. I believe every 1$ I contribute (aftertax), they contribute $1 (before tax). I was told that it is a great time to convert my 401k into a Roth IRA because 1) i am in the low bracket 2) i wont need to pay as much taxes as my investment is a little under water. Therefore it is a great time to convert. Questions 1) Am I… Read more »

Ross Williams, Grand Rapids MN
Ross Williams, Grand Rapids MN
8 years ago

I don’t know the answer to all of Allan’s questions, but he raises an excellent point that relates to “tax diversity” and age. Most people are going to move into a higher tax bracket as they get older. That means the tax deferral from a traditional IRA has a larger benefit. On the other hand, when you are in a very low tax bracket the Roth contribution is taxed at that lower rate. So if you are looking to have “tax diversity” in your retirement funds, putting money into a Roth when you are younger and in a lower tax… Read more »

shkim.K
shkim.K
8 years ago

Every one pays tax.Well there are some exceptions to that.I am not in numbers but i know how to handle money wisely.Almost all of the people in United States have credit cards.Just a couple years ago, credit cards were the weapon of choice for most American customers. The Good Recession of 2008 changed all that. The use and balances of credit cards by American customers has fallen drastically in the last three years. And while that may be smart and responsible from the standpoint of personal finances, the good sense of these consumers does have a negative effect on a… Read more »

Dee
Dee
8 years ago

Question on Roth IRA’s.
Can it be used to buy stock in a Private Company.
My friend is launching a new venture and has offered to sell me 1,000 share of stock in it for $1,000.
Can I put some of my Roth IRA money into it and how do I hold the stock if allowed by the Roth IRA plan.

Steve
Steve
8 years ago
Reply to  Dee

You need what is called a “self directed IRA,” but it should be possible. This is a specific enough question that you should probably consult an accountant.

Alex Fuller
Alex Fuller
6 years ago

So if I have $20k saved up in a 401k, and I’m going to grad school for two years, is there any problem rolling the 401k over to a Roth IRA while I’m in school making very little?

fred
fred
4 years ago

Can I get a loan for the same amout of money in my ira and use for collateral?

Cherie Sinclair
Cherie Sinclair
4 years ago

Can I put money I gained from rental properly into a ROTH IRA? Can I put money I earned from self employment in a ROTH?

Muru
Muru
4 years ago

I am a student and have estimated to earn ~1600 in my W2 for 2016. Can I contribute all of my W2 wages to Roth IRA? Thanks

John W
John W
4 years ago

I don’t understand why Roth IRAs have contribution limits? Unlike traditional IRAs it’s being taxed. A person should be able to contribute as much as they want.

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