In a previous article, we discussed the different types of retirement plans that individuals and companies have access to. One very important plan that we didn’t mention is the Roth IRA. This is because it warranted a separate article of its own.

Here, we will discuss Roth IRA in more detail to help you understand its real value and to help you make an informed decision about the same.

What is a Roth IRA?

Roth IRAs are special retirement accounts where you pay taxes on the money that you put in, but won’t have to pay taxes later on when you take the money out. These accounts are particularly useful when you think that the upcoming tax regime – or by the time you retire – will implement higher taxes on withdrawals than are applicable right now.

These are, in essence, opposite to 401(k)s where you pay taxes when withdrawing but not when contributing. However, with Roth IRAs, there are certain conditions that you need to satisfy to receive your withdrawals tax free. These IRA accounts are named after William Roth, the Delaware Senator who introduced these in 1997.

Limitations

When contributing to Roth IRAs, it is important to remember that there is an upper cap to how much you can deposit in these accounts and how much you earn each year before becoming ineligible. In 2021, singles can only create Roth IRAs if their income is below $140,000 while for married individuals the limit is $208,000.

Contributions also change with time. In 2021, you can contribute $6,000 at most if you are less than 50 years old. If you are 50 or above, the upper cap gets raised to $7,000.

Funding Sources

When looking to fund your Roth IRA accounts, you can make contributions through the following sources:

-Regular contributions made voluntarily
-Contributions made by spouses
-Rollover contributions
-Conversions from other IRAs

Withdrawls

Individuals can withdraw their contributions at any time and they will be tax and penalty free. However, if you are looking to withdraw any returns generated by the account, you can do so only after 5 years of forming the account. Furthermore, the holder must be at least 59 ½ years old. If the earnings are withdrawn before the 5-year & 59 ½ years old mark, a 10% penalty and taxes may be charged. Following are some exceptions to the penalty rule:

-Purchasing a first home, up to $10,000
-Unreimbursed medical expenses, in certain situations
-Qualified higher education expenses for you, your spouse, or grandchildren
-Childbirth/ adoption expenses, up to $5,000
-Disability
-72(t) payments

Please note that you will still owe taxes on earnings taken out of your Roth IRA even if the penalty is avoided. Uncle Sam wants their money! The list above may not be inclusive of every exception and exceptions change all the time so be cautious and seek updated advice.

There is often a debate among people whether they should convert their IRA into Roth IRA or not. Both IRAs have their own sets of rules and regulations and we would advise that you consider your position carefully and make a decision accordingly. 

If you are confused or don’t know the full extent of your decision, we suggest you get in touch with us. You can write to us and we’ll get in touch with you or simply call us to schedule a strategy session with our Roth IRA experts.