Roth IRA's can be one of the most valuable vehicles available in terms of building wealth.

But, only 6.6% of Americans own one.

Here's everything you need to know about the Roth IRA: (and why you should have one)

 

 

What is a Roth IRA?

A Roth IRA is an "Individual Retirement Account." Unlike a 401(k) where your employer provides it for you, you must open this account yourself. You can open a Roth IRA with any of the most popular brokers, such as Charles Schwab, Vanguard and Fidelity

 

How does a Roth IRA work?

You contribute money you already paid taxes on (AKA: net earned income). Then, you invest the money you contributed. A common misconception is that the Roth IRA is an investment, which isn't true. It is simply the investment vehicle. You can subsequently buy and sell investments WITHIN the account.

 

What makes the Roth IRA special?

Two things. 1. Tax-free growth & 2. Tax-free withdrawals. You can buy and sell stocks within a Roth IRA as you please without getting taxed. You can later withdraw the money you made without paying taxes as well. But there's a catch...

 

Roth IRA Rules

1. There are income limits for high earners.

2. Tax-free withdrawals occur only after an individual reaches the age of 59 1/2.

3. The annual contribution limit is $6,000 in 2022 and $6,500 in 2023.

4. The account must have been open for 5+ years before the tax-free withdrawals can occur. Let's break each rule down...

 

Rule 1: Roth IRA Income limits for 2022 are: Single tax filing status: $144,000 Married filing jointly: $214,000

&, in 2023, they are: Single tax filing status: $153,000 Married filing jointly: $228,000

If you make more than those amounts, you cannot make an outright contribution to a Roth IRA. But there's an exception...

 

Exception for Rule 1A "Backdoor Roth IRA"

A backdoor Roth IRA is in reference to someone making a Traditional IRA contribution and then converting the money to a Roth IRA.

How to do it: 1. Open a Traditional IRA 2. Contribute money 2.5 Don't invest money 3. Convert to Roth IRA 4. Invest the money

Please consult a financial professional before attempting!

 

Rule 2: Tax-Free withdrawals. You can't withdraw gains tax-free until you reach age 59 1/2. If you choose to withdraw gains before age 59 1/2, you will incur penalties. However, you can withdraw CONTRIBUTIONS without incurring any penalties or taxes. Again, there are exceptions...

 

Exception for Rule 2: Early withdrawals. You can avoid penalties if you withdraw for the following reasons: 1. Disability/death 2. Educational expenses 3. Birth/Adoption expenses 4. Health insurance, if unemployed 5. Unreimbursed medical expenses 6. First-time home purchase (up to $10k max)

 

Rule 3: Annual Contribution Limit Contribution limits for 2022 are $6,000/year. For 2023 it's $6,500/year. But if you're age 50 or over, there's an exception...

 

Exception for Rule 3: Annual Contribution Limits for Individuals who are age 50 and over are higher than others. For 2022, an individual age 50 or older can contribute up to $7,000/year. For 2023, an individual age 50 or older can contribute up to $7,500/year.

 

Rule 4: Your Roth IRA must have been opened for at least 5 years before you can withdraw from it without penalty. This is in addition to the age requirement of 59 1/2 AND includes contributions. But the same exceptions for Rule 2 apply to this one as well.

 

 

Should you open a Roth IRA?

A good rule of thumb is if you expect your tax bracket to be higher in the future than it is now, you should open and fund a Roth IRA if possible. By doing so, you would be hoping the taxes you pay now (when your bracket is lower) should be advantageous in comparison to paying taxes on withdrawals later (when your bracket is higher).