Many well-meaning people take the benefits of a Roth IRA for granted. With the tax benefits of a Roth IRA, modest contributions over long periods can translate into a substantial amount of tax-free income throughout your entire retirement. Those with the highest incomes may dream of the potential for a significant amount of tax-free retirement income, but they often earn too much income to be able to contribute to this type of retirement account. And sadly, their wealth managers are usually too lazy to set up these accounts for them when they are eligible to contribute. The responsibility to set up and fund a Roth IRA falls squarely on the rest of us.
Roth IRA Basics For 2024
A Roth IRA is one type of tax-advantaged retirement account. Unlike a traditional IRA or 401(k), you will not receive a tax deduction for your contributions to a Roth IRA. However, your investments inside a Roth IRA will not only grow tax-free, but they can also be withdrawn tax-free during retirement. (That’s assuming you follow a few basic Roth IRA rules).
Should You Contribute To a Roth IRA While You Can?
For 2024, if you are married and filing jointly, each spouse can make a maximum Roth IRA contribution of $7,000 if they have an AGI (adjusted gross income) of less than $230,000. For singles, that number is lower at $146,000. Contribution limits drop if you earn more than these amounts, and you can’t contribute at all if you are lucky enough to earn more than $240,000 as a married couple and $161,000 as a single taxpayer. Notice that there is a marriage penalty in play here. It would be great if the income limits for married couples were double those of two single taxpayers.
If your income is close to those threshold limits, consider saving the $7,000 throughout the year into a regular investment account. Then, take those funds and put the maximum amount you are allowed into the Roth IRA when filing taxes, assuming you’re eligible to contribute. Saving the money is the hard part, and it is much easier to come up with $7,000 if you have a year to do it rather than when you are staring down the barrel of the Roth contribution deadline (typically right around April 15 each year).
Are There Roth IRA Catch-Up Contributions?
There is an allowable Roth IRA catch-up contribution of $1,000 per year for those who have reached the age of 50, bringing the total contribution to $8,000 for tax year 2024.
The tax-free growth and tax-free withdrawals become more valuable the more time you give your Roth IRA to compound in value. The more your Roth IRA grows, the more potential tax savings you can reap in retirement.
Spousal Contributions To A Roth IRA
Even if only one spouse works in your household, you may still be able to benefit from a Spousal Roth IRA. Whether your life partner is a stay-at-home parent or has chosen not to work, a spousal contribution will allow your household to contribute more to a Roth IRA each year, assuming you qualify for Roth IRA contributions based on the previously mentioned income limits.
Roth 401(k) Or Roth IRA?
If your employer offers a Roth 401(k), this is typically the easier option. You can make contributions right out of your paycheck. The contribution limits are also higher. In 2024, you can contribute $23,000 to a Roth 401(k). The catch-up contribution for a Roth 401(k) is also larger, at $7,500 per year.
If you want to maximize your tax-free income in retirement, you may want to consider fully funding both a Roth IRA and a Roth 401(k).
What Is The Roth IRA Five-Year Rule?
To have full access to your “tax-free withdrawals,” you must fulfill the Roth IRA five-year rule. This IRS rule says you can’t withdraw your Roth earnings tax-free without owing taxes for at least five years from the beginning of the tax year for which you made your first Roth IRA contribution. This applies even if you are retired and/or older than 59.5.
Of course, you can withdraw all the money you contributed to a Roth IRA anytime. If you’ve been saving for years and have a substantial amount in your Roth IRA, this rule shouldn’t cause much of an issue. On the other hand, if you are starting to invest for retirement at a late age, work with your CPA and fiduciary financial planner on a smart withdrawal strategy so you can potentially avoid unwanted taxation on your Roth IRA distributions.
Can You Get a Tax Deduction for Roth IRA Contributions?
It’s shocking, but there is actually something in the IRS tax code that exclusively benefits those in the lower-income tax brackets. As you already know, you typically don’t get a tax deduction when contributing to a Roth IRA. But remember, you also don’t have to pay taxes when you make withdrawals in retirement. (If you follow the simple Roth IRA rules.)
There is an extra tax bonus for low-income workers who are savvy enough to make Roth IRA contributions. This bonus comes in the form of the saver’s credit. If, in 2024, you make less than $38,250, single, or $76,500 as a married couple, you could potentially receive a tax credit for 10-50% of your contributions to a Roth IRA. This credit is a dollar-for-dollar reduction of your taxes owed. A tax credit is more valuable than a tax deduction. You can receive the credit as a refund for those who don’t owe taxes.
Just for illustration, if you were to contribute $7,000 to a Roth IRA from age 25 until age 70, how much money do you think you would have? You would have contributed $245,000, which is not a small amount. Assuming a 10% annual return, your Roth IRA could potentially be worth more than $1,897,000. All this money can be withdrawn tax-free. If this isn’t the motivation to start a Roth IRA today, I don’t know what is. The earlier you start investing for retirement, the more likely you are to become a Roth IRA millionaire.
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