Monday, May 27, 2019

Roth IRAs: How They Work and How To Use Them

Roth IRAs differ from other tax-favored retirement plans, including other IRAs (called "traditional IRAs"), in that they promise complete tax exemption on distribution. There are other important differences as well, and many qualifications about their use. This Financial Guide shows how they work, how they compare with other retirement devices--and why YOU might want one, or more.

 

How Contributions Are Treated

The 2019 annual contribution limit to a Roth IRA is $6,000 ($5,500 in 2018). An additional "catch-up" contribution of $1,000 (same as 2018) is allowed for people age 50 or over bringing the contribution total to $7,000 for certain taxpayers. To make the full contribution, you must earn at least $6,000 in 2019 from personal services and have income (modified adjusted gross income or MAGI) below $122,000 if single or $193,000 on a joint return in 2019. The $6000 limit in 2019 phases out on incomes between $122,000 and $137,000 (single filers) and $193,000 and $203,000 (joint filers). Also, the $6,000 limit is reduced for contributions to traditional IRAs though not SEP or SIMPLE IRAs.
You can contribute to a Roth IRA for your spouse, subject to the income limits above. So assuming earnings (your own or combined with your spouse) of at least $12,000, up to $12,000 ($6,000 each) can go into the couple's Roth IRAs. As with traditional IRAs, there's a six percent penalty on excess contributions. The rule continues that the dollar limits are reduced by contributions to traditional IRAs.


How Withdrawals Are Treated

You may withdraw money from a Roth IRA at any time; however, taxes and penalty could apply depending on the timing of contributions and withdrawals.


Qualified Distributions

Since all your investments in a Roth IRA are after-tax, your withdrawals, whenever you make them, are often tax-free. But the best kind of withdrawal, which allows earnings, as well as contributions and conversion, amounts to come out completely tax-free, are qualified distributions. These are withdrawals meeting the following conditions:
1. At least, five years have elapsed since the first year a Roth IRA contribution was made or, in the case of a conversion since the conversion
occurred and
2. At least one of these additional conditions is met:
  • The owner is age 59 1/2.
  • The owner is disabled.
  • The owner has died (distribution is to estate or heir).
  • Withdrawal is for a first-time home that you build, rebuild, or buy (lifetime limit up to $10,000)

    Ordering Rules for Distributions

    If you receive a distribution from your Roth IRA, that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions) and earnings are considered to be distributed from your Roth IRA. Order the distributions as follows.
  • Regular contributions.
  • Conversion contributions, on a first-in-first-out basis (generally, total conversions from the earliest year first). See Aggregation (grouping and adding) rules, later. Take these conversion contributions into account as follows:
    • Taxable portion (the amount required to be included in gross income because of conversion) first, and then the
    • Nontaxable portion.
  • Earnings on contributions.
Disregard rollover contributions from other Roth IRAs for this purpose.

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