Questions and answers about Roth IRAs (Updated!)
The series on Roth Individual Retirement Arrangements (Roth IRAs) has covered a number of topics — what they are, how (and where) to open one, and which investments are best. Now, in the final part, we turn to some of your questions. Remember: I am not a financial adviser. I’m just a regular guy trying to gather information to help you. If you need more specific answers, please consult a CPA or an investment professional.
All of the questions below were submitted by Get Rich Slowly readers via comment or email. If your question isn’t here, please drop us a line so we can research an answer and add it to the list. If you are new to Roth IRAs, this article is not the place to begin. Start here, instead.
Types of Accounts and How Much You Can Contribute
Which is better: Investing in a Roth IRA with after-tax dollars or investing in a 401(k) with pre-tax dollars?
- Also, does it make a difference if there is an employer match?
- And if I already have a 401(k) through work, then why would I want to add to a Roth IRA?
There are a lot of variables here, so the answer for your situation may be different. But the traditional answer to this question is to…
Invest in the Following Order:
- If your job offers a 401(k), contribute to that each year until you’ve reached the limit of the employer match. Never turn down free money!
- If you still have money to invest, contribute to your Roth IRA.
- If you still have money to invest, then max out your 401(k).
- Once you’ve contributed all you can to these investments, then invest however you see fit in regular, taxable accounts.
Some people like to have all their accounts in one place. If you’re this sort of person, you may benefit from simply putting all your money into a 401(k) and not worrying about a Roth IRA.
However, there is another wrinkle to consider: When debating whether to invest in a 401(k) versus a Roth IRA, why not check with your employer to see if they offer a Roth 401(k) which allows you to invest with after-tax dollars (and withdraw tax-free in retirement)?
Also note that you can actually invest in both a 401(k) and a Roth IRA as long as you meet the requirements for both programs.
Is It Possible to Roll a 401(k) Into a Roth IRA?
It is possible, but you have to be careful. It is not a one-step process. Also, it’s difficult to do with an active 401(k) account. A mistake along the way could cost you a lot of money, so it’s a good idea to consult a financial adviser for help.
Here’s a discussion of the subject in the forum.
Can I have more than one Roth IRA? For example, can I have one at USAA and another at Vanguard?
To understand the answer, let’s step back and look at what an IRA is exactly: The “A” in IRA does not stand for “account.” If you look on the IRS website, you will see that the official definition of “IRA” is “Individual Retirement Arrangement.”
Every taxpayer can have only one Roth arrangement, but you can have multiple accounts as part of that arrangement. You can have as many Roth IRA accounts as you’d like.
Contribution Limits for Roth IRAs (and Traditional IRAs)
Contribution limits for 2015 and 2016:
- Under 50 years of age: $5,500
- Age 50 and over: $6,500
Note that your contribution limit applies to all of your IRA accounts (Roth and traditional) collectively; they don’t each get a $5,500 limit. In other words, you can contribute $100 each to 40 different Roth IRA accounts, but not $1,000 to each of them.
Who Can Invest and are There Limitations?
Can legal U.S. residents who are not citizens open an IRA?
- Is it a good idea?
- What if I don’t plan to be in the U.S. at retirement age?
Anyone with earned income in the U.S. can contribute to a Roth IRA — citizenship is not required. However, for greater flexibility, you may want to consider a traditional IRA or other investment accounts, depending on your goals.
Be sure to check with a tax professional to see which solution best fits your exact situation.
How does the IRS know that you contributed to a Roth IRA?
- How does it know if you contributed more than you were allowed?
At the end of the year, the investment company submits Form 5498 to the IRS, which reports the amount that you invested. For example, it might show that, in 2015, you invested $5,000 in a Roth IRA. The IRS computers then match this form electronically to your tax return to check for discrepancies. If you are over the income limit, your return will be flagged.
What happens if I contribute too much to a Roth IRA?
If you contribute more than allowed, you are subject to a 6 percent excess-contribution penalty. However, you have until the annual contribution deadline (generally April 15th) to withdraw any overage from the account before the penalty is assessed.
What options are there if I earn too much to contribute to a Roth IRA?
Your Contribution May Be Affected by Your Modified AGI
These tables show whether your contribution to a Roth IRA is affected by the amount of your modified AGI as computed for Roth IRA purposes. They show how to determine the amount of Roth IRA contributions that you can make for …
If you make too much to contribute to a Roth IRA, be sure you’re maxing out your 401(k), if you have one. You can also contribute to a traditional IRA.
Both of these are excellent options. But note that, if you have a 401(k) at work, your contributions to a traditional IRA may not be tax deductible. Another option for high-income individuals to consider is to contribute to an annuity.
Here are two more forum discussions about Backdoor Roth and 401(k) rollover strategies and What to do when Roth IRA isn’t an option.
My wife is a stay-at-home mom and doesn’t have any earned income. Does this mean she cannot have a Roth IRA?
To every rule, there is an exception. If you are married and filing a joint return, then both spouses can max out IRAs from a single income (so long as the other Roth IRA requirements are met).
I’m self-employed and I make more than the maximum allowable for a Roth IRA. Does a SEP-IRA make sense?
A SEP-IRA may make sense, but that will depend on your individual circumstances. Basically, self-employed people can contribute roughly 20 percent of their first $200,000 of pre-tax earnings to a SEP-IRA. However, they must contribute the same percentage for all employees. If you are the only employee, or if you don’t mind giving all employees the same retirement benefits, then this may be a good choice. This is another case in which you should consult a financial adviser.
Types of Roth IRA Investments
I want to open a Roth IRA, but I’m confused by the mutual funds offered by different companies.
- For example, ING Direct (now Capital One 360) offers six funds, and another bank offers only five. What’s the difference?
- Which should I choose?
Only you can answer that question. Here’s how I would approach this problem: I would first locate the investment I want to purchase. Is it an individual stock? Is it real estate? Or is it, as I encourage, an index fund?
Once you’ve decided on an investment, then find a company that will let you buy the investment from within a Roth IRA at the lowest cost. This shouldn’t take too much effort. If, like me, you decide you like Vanguard’s mutual funds, then open an account directly with Vanguard.
Can I really use my Roth IRA to buy a house?
Sort of. There’s an animal called a self-directed IRA which allows you to invest in real estate. However, you cannot invest in anything directly related to you, like your company or your primary residence. This is definitely a topic you should take up with a tax professional if you have a strong interest in doing something like this.
In many cases, complex Roth IRA questions are best answered by a qualified financial professional. Each person’s situation is different. It is difficult to give one-size-fits-all advice in the context of this blog. Use the National Association of Personal Financial Advisors to find an independent, fee-only adviser.
I opened a Roth IRA at a local bank, but I noticed that I’m only getting a 1.98% return. This seems unusually low. Should I withdraw my money and move it to Vanguard, Fidelity, or T. Rowe Price?
Your money is probably in a savings account or certificate of deposit. Your bank may offer additional financial services — check with them to see where else you can put the money. Barring that, yes, absolutely move the money to a different location. You may have to pay a transfer fee, but it’s worth it.
As Mandy writes in the forums, “Traditionally, banks are one of the worst places to invest because they typically offer high-load/high-fee or very conservative investments and charge higher service fees than most other brokerages. Banks are for banking, not investing.”
(See Which investments are best for a Roth IRA? for ideas on where to put the money.)
Withdrawing From a Roth IRA
Can I really withdraw money from my Roth IRA without penalty?
That depends on what you would consider a penalty. Here is a direct quote from the IRS website:
“You can take distributions from your IRA (including your SEP-IRA or SIMPLE-IRA) at any time. There is no need to show a hardship to take a distribution. However, your distribution will be includible in your taxable income and it may be subject to a 10% additional tax if you’re under age 59 1/2. The additional tax is 25% if you take a distribution from your SIMPLE-IRA in the first 2 years you participate in the SIMPLE IRA plan. There is no exception to the 10% additional tax specifically for hardships. See chart of exceptions to the 10% additional tax.”
[Source: https://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-IRAs-Distributions-(Withdrawals)]
Source: IRS.gov Publication 590b – Fig. 2.1 https://www.irs.gov/pub/irs-pdf/p590b.pdf
The GRS Introduction to Roth IRAs series
Understanding how important it is to get started saving for retirement, check out the rest of our Roth IRA series to learn about how to start your Roth IRA, which investments are best, and other general questions about these great accounts.
Part 1: The extraordinary power of compound interest
Part 2: What is a Roth IRA and why should you care?
Part 3: How to open a Roth IRA (and where to do it)
Part 4: Which investments are best for a Roth IRA?
Part 5: Questions and answers about Roth IRAs
[Thanks to all of the people who helped put this series together, including William Cowie, Vincent, Sabino, Dylan, Mandy, and tindyhands.]
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There are 35 comments to "Questions and answers about Roth IRAs (Updated!)".
Just when I thought I knew everything about a Roth IRA, you make a post like this. Thanks!
The home purchasing point was new to me, and it’s interesting to consider using a Roth as a vehicle for storing money for a down payment (while making sure retirement contributions are set aside as well).
I am just starting to save for a house downpayment, but it still doesn’t seem worth trying to use a Roth IRA for that. Say I make 7% interest on the $10,000 I withdraw to put towards a down payment. Then I’ve made $700 in interest, which is tax free, but is only saving me about $175. To me, it doesn’t seem worth the hassle.
I suppose that’s for people who had originally saved the money for retirement but instead want to use it for a down payment, which doesn’t seem like a very wise choice.
Personally, I wouldn’t use the money from my Roth IRA to purchase a house, either, but the option *is* there.
That house-buying option may encourage people to put more money in their IRA than they otherwise might without worrying that they might later have wished they had saved some of it for a down payment instead.
**
Great article. I have one more comment on the decision between IRA and 401K. I would prefer an IRA or even just investing the money outside of any plan over investing in a 401K that has only options with high fees, only (or too much) company stock, or only annuities rather than stocks or bonds. If there was company matching, that would probably make up for those disadvantages, but beyond that, no.
Remember that if you just invest your money yourself, the investment is in after-tax dollars, and the growth (dividends and capital gains) are generally taxed at a lower rate than income, so it’s still a good deal.
Thank you so much for this information! My husband just left his company, and I was wondering if he could roll his 401k into a Roth IRA. Now I know that we can!
thanks for this excellent series. It came at a perfect time as I was researching my retirement options.
There’s also a Roth 401(K) that was started this year. Same contribution limits as the Traditional 401(K), but you don’t get taxed later as with a Roth IRA.
Man, this is brilliant. Thank you. Now that I’ve looked into a couple of the options you’ve mentioned I realize I don’t know how to find an IRA that lets me choose socially responsible mutual funds. Any ideas?
My husband and I are currently living in another country, already have Roth IRAs and we were both earning money in the US up until June. So, are we allowed to contribute this year, but not in future years when we are not earning money in the US?
The last answer is out-and-out wrong.
“Can I really use my Roth IRA to buy a house?”
You CAN purchase real estate within a Roth IRA (or a traditional IRA), but only for investment purposes, meaning it cannot be a residence for you or your immediate family. You also have to find a trustee for this; it’s not that difficult, but definitely more work than just buying Vanguard funds!
RE: I have a bank account in the U.S. Can I start a Roth IRA if I live and work in another country? I’m afraid to save in my country’s currency because inflation will ruin my investments.
I’m a US citizen who currently works in another country, and was looking into starting an IRA because my company doesn’t have a contribution-based retirement plan I can use. Does this “US income only” rule apply to Roth IRAs only, or normal IRAs also? Can you also link me to where it says that you must have “US income” to contribute? Poking around Vanguard’s site, it’s not something I’m finding as a requirement, though I know it’s an unusual circumstance.
Another wrinkle to the 401(k) / Roth IRA debate is to look at your marginal tax rate. When I had a marginal tax rate of 38-46%*, I totally maxed out the 401(k) – well past the employer max – because I’d rather put the 38-46% into my 401(k) than send it to the Treasury.
If my marginal tax rate had been 10% then a Roth might have been a better deal…once Roths came into being, of course 🙂
*Due to nonqualified stock options which are treated as ordinary income…
Er, well past the employer MATCH, not employer max.
I have both an Roth IRA and a 401k. The question that remains for me is should I invest them differently? I currently have both in the Fidelity Freedom Fund 2050. Is that smart or should I move one into a different mutual fund?
What if you start out under the maximum earned income per year, and you have only invested half of the allowable amount into your Roth. Your earned income then suddenly jumps past the max. Can you still keep your Roth IRA?
Serving over 27 years in the air force, my husband passed away two years ago. I haven’t worked in over 8 years. My son and I were left lump sums of money from life insurance policies, with wish i ‘paid’ off my home. My question is am I able to invest in a roth ira account without a job? Again, the ONLY income I have is from social security for my son and I, which my ss check cease July ’08,’ because my son will turn 16. And my V.A. benefit and SBP benefit, which my SBP benefits are taxed. I DON’T know what to do. Before his death, my husband closed out his roth ira account. All suggestions will be greatly appreciated. Thank you.
I wrote a similar article today about this – I have been wondering about my ROTH and more importantly, if I could open another one because I’m very disappointed in how the current one is functioning – but yes, very good post – I can take a stab and #15 and #16 for you:
#15 CHR – It’s up to you on the investment – it looks like the FFFHX is a very new fund but has a good expense ratio and is a LargeCap Growth fund – Sounds like you’re young and if the fund is performing like you want, you should be good for now (as far as diversification, it is a mutual fund, so it is inherently diversified already!)
#16 Jeremiah – I’m not 100% sure (but maybe 98.28% sure as I’m not a financial guru), but it is based on what you make through the year, so if you’ve contributed $2000 up until June and then your income jumps to a combined 200k yearly, take into account that you will only be making HALF of that 200k in the calendar year (because you’ll only get paid that salary from June-December) so it might fall at around 175k for the year – and if that’s the case, I’d try to offset your MAGI score by dumping MORE into your 401k to be eligible for the ROTH as long as you can – granted, it’s a good problem to have making that kind of $$$, and you can still contribute to a Traditional IRA if you’re forever over that limit –
Hope that helps –
Hank
If I earn $100,000 a year and my wife not working, and we filed tax jointly,
Questions: Can I max out the $15,500/year contribution limit for 401(k) plan with my employer? Can I also max out the $4000/year contribution limit for Roth IRA for my wife and I, totaled $8000 for Y2007?
I want to assist my married children in getting a Roth started. I will make contributions for them while they are young and poor but I would like to have some say should something happen to them. Can I be the beneficiary of the account I contribute to?
I was wondering if someone could clarify something for me. From what I understand I don’t think the section about withdrawling your contributions penalty free is correct. In your example you have a Roth IRA in which you contributed $4000 and it is now worth $5000 ($1000 in earnings). Your account is made up of 80% contributions and 20% earnings. Any withdrawls that you make will be made with that ratio. So in your example when you withdrawl $4000, $3200 will be penalty free, but the IRS will treat $800 (20% of your withdrawl amount) as earnings and penalize you accordingly.
Kevin, I don’t think that’s how withdrawals work. It’s my understanding that you withdraw 100% contributions and then earnings. More here.
Can I contribute to my Roth IRA while living in another country? I moved in April.
Can I buy individual stocks with my roth ira contribution?
I got terminated from my job last August 2008 which put me in a deep financial situation in paying my mortgage. Is it okay if I cash my IRA which is worth $136,000 and how much do you think I would get in gross money after taxes and penalty?
I am a reader from the UK, is it possible for a UK resident to open a roth IRA or is there a UK equivalent?
Like many of your readers, I make too much money to contribute to a Roth IRA. I opened a non-deductible traditional IRA last year, and I intend to roll my traditional IRA into a Roth IRS next year (NB: I don’t have any deductible IRA contributions).
I’ve been buying a REIT index fund (automatic investing) for the past 18 months or so.
I’m sure it will come as no surprise that the balance of my IRA is now lower than the amount I’ve contributed to it. I’d imagine it will still be lower than the amount I’ve contributed to it in 2010, when I roll it into a Roth IRA.
My question: if my traditional IRA balance is lower than the amount I’ve contributed to it at the time I make the conversion to a Roth IRA, can I deduct the loss from my income by reporting a tax loss on my tax return?
I know I couldn’t do so if I were converting a traditional deductible IRA to a Roth IRA, since the funds are only taxed at withdrawal (so there would be no tax loss), but since I am only converting non-deductible funds, there IS a tax loss. I’ve searched high and low, but I haven’t found any articles or commentary that address my situation. I’m sure there are other readers in the same boat.
Can you please point us in the right direction? Thanks very much.
I’m 67, want to know what options I have about roth iras?
I have 5,000 in a Roth IRA since 2002 in Priamerica invested in mutual funds. I did not understand the concept of investment in mutual funds and now I am surprised to find that the value of this investment is a little over a thousand dollars.
I read that the contribution to a Roth IRA can be withdrawn at anytime, but the earnings only after age 59 1/2 and after 5 years have passed. I am 67 and the 5 year period has passed.
Now that I want to withdraw both the contribution and the earnings, both these have dissappeared, it is the “balance of the account” that can be withdrawn.
Is that how it works with investment in Mutual Funds?
Are there penalties or taxes on withdrawals after age 59.5? I want to know if I can use my Roth to pay off Parent Plus loans once my eldest has graduated from college. I will be 60 when he graduates.
I am in my mid 40’s and wanting to start contributing to an IRA. Starting so late in the game, what is the benefit of an IRA vs a Roth IRA?? Thank you!
I am 77 years old. I have a Roth IRA stock trading account with Scottrade If I make or lose
money do I have to report it on Schedule D of the IRS 1040
Thanks for the great article! I have a complicated Roth IRA question I wouldn’t mind you helping me sort out. The info just isn’t out there. I’m trying to find out how much I can contribute to my IRA.
I live and work in Asia, and have a Roth IRA that I would like to contribute to. I have a salary, which is under the Foreign Income Exclusion of 92.21K, so I report that on my tax return, but don’t pay taxes on it. I do pay taxes for a very small earnings off of a stock sale–well I would if it was big enough, but it IS a taxable income. Couple of bucks, really. I have heard that if I make less than US$2000 taxable income, I can only contribute that amount. Is that correct? So I work full time, make money full time, but only make US$500 during the year from stock sales (other than my non-taxable foreign income), I can only contribute $500?
All the literature/websites state that if you make “any taxable income”, you can contribute, but they don’t specify if you can contribute the full amount. I don’t buy it. Can you clear this one up?
Well, it is more complicated than that, there are 2 issues, they are saying that Southern is a disqualified entity as to you because “in theory” they feel you really manage it even though your structure is set up otherwise. (LLC owned 100% by Self-Directed ROTH IRA managed by an unrelated 3rd party)
Then the 2nd issue comes into play, since they have determined that the LLC is actually you, then your adult children in essence made a loan to you from their Self-Directed ROTH IRA’s which is a prohibited transaction.
I am not even sure if I have worded it properly but I think they would get the drift.
Ok, here’s a follow up question to the following entry:
“What happens if I contribute too much to a Roth IRA?
If you contribute more than allowed, you are subject to a 6% excess contribution penalty. However, you have until the annual contribution deadline (generally April 15th) to withdraw any overage from the account before the penalty is assessed.”
So, let’s say someone drops $10k into a Roth IRA on May 1, 2013. They’d accumulate more earnings in their account than if they contributed the maximum $5,500, but they’d be subject to the 6% penalty. UNLESS they withdraw the $4.5k overage in contributions, BEFORE the deadline (let’s say they did that April 1). Then, they’d be investing more than the max, thus getting greater compounded returns (tax free). They also wouldn’t pay the penalty, since they took out the contribution that put them over the maximum.
Is this a loophole? Or did I misunderstand or miss something?
I had a Roth account with someone, but had financial difficulties and had to withdraw all of the money. At the same time, I opened a simple Roth with an on-line banking institution. Is the second account good or am I not allowed to open the second account?
Your answers are very helpful. Even though the Roth IRA has been around for more than 10 years, people still have a lot of questions about how it works.