There’s no age at which account owners must begin to take money out of their Roth IRA. This makes the account a good choice for those who want to pass along wealth to their heirs or loved ones. You can only contribute money to a Roth IRA if your modified adjusted gross income (MAGI) is less than a certain threshold. You can invest the money you add to a Roth IRA in assets of your choice, such as stocks, bonds, or mutual funds. The money you add to your Roth IRA won’t reduce your taxable income, but the earnings will grow tax free. In fact, you don’t even have to report the earnings to the Internal Revenue Service (IRS). You don’t have to pay taxes on much of the money that you withdraw either. This is true even after you retire and when you first tap your Roth IRA for income. “Qualified distributions” that aren’t taxed are those you take after you reach age 59½ and at least five years after the tax year in which you first added money to the Roth IRA. But you might pay an extra 10% penalty if you withdraw money outside of these times.
A Roth IRA Example
Suppose that you’re 35 years old when you open a Roth IRA. You decide to add $6,000 (after tax) to the account each year. You earn a return of 6% each year. You can’t deduct that $6,000 from your taxable income, your account would be worth $474,349 in 30 years, when you’re 65, at that rate of return. You wouldn’t lose any of that to taxes as long as you take money out after the age of 59½ or for other qualifying reasons cited by the IRS. Your take-home savings would be the full $474,349.
How Much Can I Contribute to a Roth IRA?
There are limits on how much you can add to your Roth IRA each year. Your maximum contribution to the account is the lesser of your taxable income for the year or $6,000, or $7,000 if you’re 50 or older, for the 2022 tax year. This is $6,500 or $7,500 respectively in 2023. Your taxable income includes wages, salaries, and net self-employment earnings, but it excludes the money you make from interest or dividends. You don’t have to make the full contribution at once even though the limit is set per year. You can make several smaller contributions as long as the total amount doesn’t exceed the limit for the year. You can even contribute to both a traditional IRA and a Roth IRA as long as the combined amount doesn’t exceed the limit. The amount you can add to a Roth IRA is further restricted by your modified adjusted gross income (MAGI). You can contribute up to the limit for tax year 2022 if your MAGI is less than $204,000 a year and you’re married and filing a joint return. It’s $129,000 if you’re single, head of household, or married and filing a separate return and you didn’t live with your spouse at any time during the year. The limit drops to $10,000 if you did live with your spouse and you file a separate return. The amount you can contribute after you reach this threshold begins decreasing until you can no longer contribute anything at all at MAGIs of $214,000 a year if you’re married and filing a joint return, or $144,000 if you’re a single filer, head of household, or married and filing a separate return and you didn’t live with your spouse. You can contribute the full amount in 2023 if your MAGI is less than $218,000 a year and you’re married and filing a joint tax return. The amount you can contribute after you reach this threshold begins decreasing until you can no longer contribute anything at all at a MAGI of $228,000 a year. Each Roth IRA contribution limit relates to a certain calendar year. You can add money to your Roth IRA from Jan. 1 of that year until the filing deadline for your tax return. You have until April 18, 2023, the due date for your 2022 return, to make 2022 contributions. These income thresholds drop to $138,000 through $153,000 in 2023 if you’re single, qualify for the head of household filing status, or if you’re married and filing a separate return and you did not live with your spouse at any time during the tax year. Single filers can make the maximum contribution if their MAGI is less than $138,000 in 2023, less if their MAGI is less than $153,000, and nothing at all if their MAGI is $153,000 or more.
Alternatives to a Roth IRA
You might want to look into investing in a 401(k) first if your income is too high to add directly to a Roth IRA, or if you’re not ready to add much at all. Your employer may offer a match if it sponsors a 401(k) account, which can help grow your money faster. And you can add pre-tax dollars to a 401(k): money that’s not taxed as income. The downside to a 401(k) is that you’ll have to pay taxes when it’s time to take money out. Roth 401(k) contributions allow you to avoid paying taxes on distributions. Traditional IRAs also accept pre-tax dollars from people at all income levels, up to the same contribution limits as Roth IRAs. The amount you can deduct may be capped if you have both an IRA and a 401(k) through work, and if your income exceeds certain thresholds.
