Understanding Roth IRA: Key Benefits and Eligibility

Roth IRA is an excellent retirement account option for Americans as it allows individuals to contribute to their retirement account with after-tax dollars. One of the key benefits of a Roth IRA is that your money and all the earnings on that money can be withdrawn tax-free, as the amount you contributed has already been taxed. This is different from a traditional IRA, where you contribute pre-tax income, and when you take money out, you have to pay taxes on it.

Rhian Horgan, Founder and CEO of Silvur, recently shared her insights on tax season, IRA benefits, and retirement planning options in an interview with Yahoo Finance Live.

To be eligible for a Roth IRA, single filers must have an income of under $153,000 for the tax year 2023, while married couples filing jointly must have a combined income of under $228,000 for the tax year 2023. While there are limits to how much one can contribute, individuals under the age of 50 can contribute a maximum of $6,500 for this year, while those over the age of 50 can contribute up to $7,500 for 2023.

Roth IRA:Withdrawal Rules and Tax-Free Compounding

Individuals can withdraw their money penalty and tax-free after age 59 and 1/2 as long as their account has been open for at least five years. While one can technically withdraw the money at any time, taxes and penalties may apply.

Rhian Horgan emphasized that Roth IRA is an ideal option for individuals who are young and lower-income, and have time on their side as tax-free compounding of returns can be great. Other individuals interested in Roth IRAs include those whose incomes are higher than the cap and are looking at Roth IRAs as a gifting strategy for children or grandchildren. Roth IRAs can also be a great option for individuals who are close to retirement and are considering a Roth conversion or a backdoor Roth.

Roth 401(k): A Valuable Savings Tool

Rhian also highlighted the value of a Roth 401(k), which many savers are not familiar with. The cap on a 401(k), whether it’s traditional or a Roth, is much higher than the caps for Roth IRA. The cap for a Roth 401(k) is over $20,000, and employers can match that.

Strategies to Maximize Retirement Accounts

For individuals who have a traditional 401(k), Rhian suggested maxing out the Roth first, especially for those who believe that their salary and earnings will go up over time. There are income caps on contributing to Roth accounts, which means that individuals who think their earnings will increase over time will benefit from contributing to the Roth as early as possible in their career, as there may come a point in time where they are not eligible to contribute anymore. Any excess amount can be put in a traditional 401(k) or traditional IRA.

Potential Downsides

Rhian emphasized that potential downsides include paying taxes today rather than putting it away tax-free, which may not be a wise decision if your tax rates go down over time. For those considering Roth conversions later in life, it’s crucial to live for five years after the conversion for it to be effective.

Pros & Cons

Pros:

• Tax-free withdrawals: One of the biggest advantages of a Roth IRA is that your withdrawals are tax-free, which can save you a lot of money in the long run.
• A Roth IRA does not require minimum distributions, giving you more flexibility in managing your retirement funds compared to a traditional IRA that requires minimum distributions.
• Contribution flexibility: You can continue to contribute to a Roth IRA past the age of 70 1/2, unlike a traditional IRA which has contribution limits after that age.
• You can access your funds: Although withdrawing funds early is not advisable, a Roth IRA enables you to withdraw your contributions without facing penalties, making it a more adaptable alternative for saving towards retirement.

Cons:

• No immediate tax benefits: Contributions to a Roth IRA are made with after-tax dollars, meaning you won’t receive any immediate tax benefits like you would with a traditional IRA.
• Income restrictions: High earners may not be eligible to contribute to a Roth IRA, and those who are eligible may only be able to contribute a limited amount.
• Withdrawing earnings from a Roth IRA before the age of 59 1/2 or before the account has been open for five years will incur penalties, but you can withdraw your contributions without penalty.

Conclusion

In conclusion, Rhian Horgan provided valuable insights on retirement planning options, particularly on Roth IRA and Roth 401(k). Americans have many choices when it comes to saving for retirement, and it’s important to understand the benefits and eligibility criteria of each option to make informed decisions.