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A Roth IRA is a retirement savings account that allows tax-free growth on your investments. Withdrawals also are tax free on a federal basis if you meet these requirements:
However, nonqualified withdrawals generally trigger an early withdrawal penalty and federal income tax.
You can open a Roth IRA at most banks and brokerages. But some charge no management fees and require no minimum deposits to open. So be sure to compare your options.
When you open a Roth IRA, you can build a retirement investment portfolio with a variety of assets.
You fund a Roth IRA with “after-tax” dollars. This means you’ve already paid income tax on that money, so you can withdraw your contributions any time penalty- and tax-free.
However, Roth IRAs have contribution limits set each year by the IRS and based on your modified adjusted gross income (MAGI). For 2020 and 2021, that limit is $6,000 — or $7,000 if you’re age 50 or older.
But that limit applies to you if your MAGI is less than $124,000 — or $196,000 if married filing jointly. Once your MAGI goes above that amount, your maximum contribution begins to diminish until you can’t contribute at all.
| Modified AGI | Contribution |
|---|---|
| < $196,000 | up to the limit |
| > $196,000 but < $206,000 | a reduced amount |
| > $206,000 | zero |
| Modified AGI | Contribution |
|---|---|
| < $10,000 | a reduced amount |
| > $10,000 | zero |
| Modified AGI | Contribution |
|---|---|
| < $124,000 | up to the limit |
| > $124,000 but < $139,000 | a reduced amount |
| > $139,000> | zero |
You have until the next tax filing deadline to reach your maximum Roth IRA contribution.
You can open a Roth IRA at most banks and brokerage firms. Simply visit their website or a branch. Be ready with the following.
You can contribute only “earned income” or what the IRS calls taxable compensation, to a Roth IRA. This includes the following.
When you roll over money from a traditional IRA or 401(k) into a Roth IRA, you must pay taxes on the amount transferred. Your traditional IRA or 401(k) contributions and investment gains will be added to your taxable income for the year you made the transfer. That’s because the money you put into a traditional IRA is tax deductible, and you don’t pay taxes on it until you withdraw it at retirement. But qualified withdrawals from a Roth IRA are tax-free. In other words, Uncle Sam won’t give you both tax breaks.
Speak to an accountant about the tax implications of a rollover. If it makes sense, you have two options to rollover an IRA or 401(k) into a Roth IRA.
This is the simplest way to convert to a Roth IRA. Contact the financial institution holding your existing account and ask for a trustee-to-trustee transfer or direct rollover into your Roth IRA with another financial institution.
Transfers may be even easier if both accounts are with the same financial institution. But some firms may not allow this kind of transfer or rollover.
If the financial institution holding your 401(k) or IRA sends you a check or any payment of your account’s assets, you have 60 days to roll it over to a Roth IRA. Otherwise, you may face an early withdrawal penalty. So contact the financial institution holding your Roth IRA as soon as possible.
You may need to send a check by mail. If you get a payment from your 401(k) provider, your employer must withhold 20% for tax purposes. The only way around this is a direct rollover as described above.
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A Roth IRA offers multiple tax benefits. It can be particularly beneficial if you expect to retire at a higher tax bracket than you’re in now, you’re many years away from retirement and expect a lot of growth, or if you think tax rates will increase substantially, because you’ll be able to withdraw your investment earnings tax free.
But management fees and fund expense ratios can diminish these returns. So make sure you compare brokerage platforms to find the Roth IRA that’s right for you.
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