Should you invest in a Roth IRA instead of a traditional IRA? If you have earned income for the year, your modified adjusted gross income (MAGI) is less than $135,000 as a single filer and $199,000 for married filing jointly, a Roth IRA is a valid option for you.
If your MAGI is less than $118,000 and $186,000 respectively, you may contribute up to the full limit of $5,500 for the year – and if you are age fifty and above, you can contribute an extra $1,000 as a catch-up fund.
A traditional IRA may still be the best choice for you, but consider these five Roth IRA advantages.
1. Non-Taxable Withdrawals – Since Roth IRA contributions are made with post-tax dollars, you can withdraw them tax-free. Withdrawals on earnings are also tax-free if you have had the account for at least five years and you are age 59-1/2 or older.
2. No Required Minimum Distributions (RMDs) – In contrast to traditional IRAs and 401(k) plans, there are no RMDs associated with Roth IRAs. You can allow retirement funds to continue to grow tax-free for as long as you like. If you are fortunate enough not to need the money during your lifetime, you can pass the Roth account down to your heirs.
3. Tax-Free Inheritance – Your heirs will pay no income taxes on an inherited Roth IRA, as long as the account was held for at least five years prior to death. Spouses that inherit a Roth IRA may transfer it into their own Roth account and keep the same distribution rules, while other heirs must take minimum distributions depending on their choice of inherited IRA option.
4. Withdrawal Timing – While it’s not recommended to withdraw money early, Roth IRAs give you the flexibility to do so if necessary. You can withdraw up to your collective contribution amounts at any time without penalty, even if you are below the age 59-1/2 limits for traditional IRAs. Withdrawing earnings before age 59-1/2 can result in a 10% penalty along with required income tax on the earnings portion.
5. Tax Calculation Effects – Roth IRA withdrawals can have positive effects on your taxes by affecting calculations throughout the tax code. They are excluded from the calculations that determine whether any of your Social Security benefits are taxable and whether you must pay the Medicare surcharge that increases premiums for Part B and Part D above certain income thresholds.
It’s possible to maintain a traditional IRA and a Roth IRA, but all IRA contributions must stay below the annual limit. This is useful if you misjudge your income limit, as you can convert an annual contribution from a traditional to a Roth IRA and vice versa.
The recently passed Tax Cuts and Jobs Act mostly left Roth IRAs alone, but it did change one aspect – if you convert a traditional IRA into a Roth IRA, you can’t change your mind and convert back to a traditional IRA.
If you make too much money to directly contribute to a Roth IRA, you can still utilize a Roth IRA through a “backdoor” conversion. Contributions are made to a traditional IRA and then subsequently rolled over into a Roth IRA.
Generally, the Roth IRA decision boils down to taxes. Would you rather pay them now or later, and will your tax rate be different enough in the future to make a difference? Either way, Roth IRAs have enough unique properties that they provide useful flexibility in managing your retirement cash flow – and flexibility can be valuable in handling future financial surprises.
Regardless of where you plan to retire, the number one factor in ensuring that you can retire on your terms is your 401(k). Make sure that your 401(k) is maximizing its potential with this free analysis that checks your fees, fund mix, and other factors to help you hit your retirement goals.