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 of time 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 often 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 In 2022
A Roth IRA is one type of retirement account. Unlike a traditional IRA or 401(k), you will not receive a tax deduction for the money you contribute to a ROTH IRA or ROTH 401(k). However, your investments inside a Roth IRA will not only grow tax-free but they can also be withdrawn tax-free during retirement.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).
Contribute To a Roth IRA While You Can
The good news for procrastinators is that you can contribute to a Roth IRA when filing your previous year’s taxes. The sooner the contribution is made, the further into the future your potential investment earnings will be sheltered from taxation.
For 2022, if you are married and filing jointly, each spouse can make a full $6,000 Roth IRA contribution if they have an AGI (adjusted gross income) of less than $214,000. For singles, that number is a bit lower at $124,000. Contribution limits drop if you earn more than these amounts, and you can’t contribute at all if you are lucky enough to make more than $206,000 as a married couple and $144,000 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 the threshold limits above, consider saving the $6,000 throughout the year into a regular investment account. Then, take those funds and put the maximum 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 $6,000 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 15th each year).
Roth IRA Catch-Up Contributions
There is an allowable Roth IRA catch-up contribution of $1,000, per year, for those who have reached 50 years old, bringing the total contribution to $7,000 per year.
The tax-free grown and withdrawal become more valuable the longer you hold onto your Roth IRA. There is more time for compounding interest to work its magic, creating more tax savings from your Roth IRA.
Spousal Contributions for A Roth IRA
If only one spouse in your household works, you may still be able to benefit from a Spousal Roth IRA. Whether your life partner is a stay-at-home parent or just between jobs, a spousal contribution will allow your household to contribute to a Roth IRA for the non-earning spouse. Assuming you qualify for Roth IRA contributions based on the income limits mentioned above.
The Roth IRA Five-Year Rule
To have full access to your “tax-free withdrawals,” you need to fulfill the Roth IRA five-year rule. This important rule means 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 older than 59 ½.
Of course, you can still pull out all of your Roth IRA contributions at any time. If you’ve been saving for years and have a substantial 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?
For once, there is something in the IRS tax code that exclusively benefits those in the lower income tax brackets. As I mentioned, you typically don’t get a tax deduction when contributing to a Roth IRA. But don’t forget 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 2022, you make less than $51,000, single, or $68,000 as a married couple, you can 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.
Is It Possible To Become A Roth IRA Millionaire?
Just for illustration, if you were to contribute $6,000 to a Roth IRA from the age of 25 until the age of 70, how much money do you think you would have? You would have contributed $210,000, which is not a small amount. Assuming a 10% annual return, your Roth IRA could potentially be worth more than $1,626,000. 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.