A Roth IRA is a great retirement investment vehicle. Roth IRAs come with specific rules about who can use them and how to use them. But if you fit the criteria, a Roth IRA can be a great addition to your retirement portfolio.
What Is a Roth IRA?
Individual retirement accounts (IRAs), in general, are little retirement powerhouses. They are retirement-specific accounts that are not linked to your employer. Anyone over the age of 18 can open one, as long as they are earning some income.
A Roth IRA operates differently than other IRAs. Specifically, a Roth IRA has specific rules about withdrawing money, when the money is taxed and who can open an IRA.
Let’s start with taxes. Contributions to a Roth IRA are not tax deductible in the year you make them. You pay tax on the money in the year you contribute. On the flip side, you can withdraw money tax-free in retirement with a Roth IRA. These kinds of contributions are called post-tax contributions; money is contributed to the IRA after tax is paid on it.
Roth IRAs also have specific rules about withdrawing money early. You can withdraw your contributions from a Roth IRA at any time and not incur a penalty. Accounts like a 401(k) or a traditional IRA do not have the same flexibility.
It’s important to note that you can take out only your contributions without penalty. Penalty-free withdrawals do not apply to the money earned in the account. So if you contributed $10,000 in the last two years and earned $3,000 in gains, you can’t take out more than $10,000 from the account.
What Are the Roth IRA Contribution Limits?
You can put up to $6,000 a year into your Roth IRA as of 2020. This limit is unchanged from 2019. Keep an eye on the contribution limits each year. The IRS changes them periodically. Every few years, the limit increases as a way for retirement accounts to keep pace with inflation.
If you’re 50 or older, you can contribute an additional $1,000 a year to your Roth IRA for a total of $7,000. The IRS allows this for older people who may be playing “catch up” with their retirement savings. If someone was unable to contribute much to retirement earlier in life, the IRS allows them to contribute more later. This way, they retire with more financial security. But even if you’ve been contributing the maximum each year to your Roth IRA, you can still use this catch-up amount.
However, you can’t contribute more than your total earned income for the year.
For example, if you earn $4,000 during the year, you can’t contribute more than $4,000 to your Roth that year. If someone gifts you $500, you can’t contribute that to your Roth, because it is not earned income. (Check out these other income types that can be contributed to a Roth IRA.)
What Are the Roth IRA Income Limits?
As we mentioned, there are limits to how much money you can earn and still contribute to a Roth IRA. If you make over a certain amount of money, you can’t contribute to a Roth IRA. This amount depends on your tax filing status.
You can see a whole chart provided by the IRS about Roth IRA income limits and tax status here. We’ve also broken them down below.
If you are married and file income tax jointly and your income is more than $196,000, you can’t contribute the full $6,000 limit to a Roth IRA.
If you are single or married and file income tax separately and your income is more than $124,000, you can’t contribute the full $6,000 limit to a Roth IRA.
There are no income limits on traditional IRAs, which is a major difference between the two accounts. If you want to be able to contribute the full $6,000 annual limit to an IRA and you’re worried that your income throughout the year may disqualify you from doing so, you should consider a traditional IRA.
Reduced Contribution Limits
However, you may be able to contribute a reduced amount to a Roth IRA even if you make more than the income limits we mentioned.
For example, if you file your income tax as a single person and make over $124,000 but under $139,000, you can contribute to a Roth at a reduced rate. That means you can’t contribute the whole $6,000, but you may be able to add some amount under that.
If you are married and file jointly and your household earns more than $196,000 but less than $206,000, you may also be able to make a reduced contribution.
Check with an accountant to figure out exactly what your contribution rate may be.
Where Can You Open a Roth IRA?
You can easily open a Roth IRA at many of the major brokerages. This is a great option if you want to DIY your investments.
From our experience, we’ve named TD Ameritrade and E*TRADE our top picks for Roth IRA brokerage accounts.
If you’d rather take a more hands-off approach, we suggest opening a Roth IRA with a robo advisor such as Betterment or Wealthfront. These services will let you “set it and forget it,” tailoring and managing investment portfolios specifically for your retirement-saving needs.
Make sure you understand the rules about opening and funding a Roth IRA before you take the plunge. Since Roth IRAs have specific income and contributions limits, make sure that you fit the criteria.
Increase your overall retirement savings by adding a Roth IRA to your investment portfolio. If you have a workplace retirement plan, a Roth IRA can help round out your investment plan and give you a chance to stash away even more money for retirement.
If you don’t have a workplace sponsored retirement plan, a Roth IRA can be a fantastic way to get started saving for retirement. The Roth IRA contribution limit of $6,000 for 2020 is a much more manageable number to aim to save than with some other retirement accounts.
Written by Kara Perez.
View the original article at here.