Rules are meant to be broken — or at least changed.
So whether you’re beginning to learn about investing or really know your stuff, you’d be excused for not knowing the ins and outs of Roth IRAs. The IRS updates the rules annually.
If you need to brush up on current Roth IRA rules, you’re in the right place.
The first rule of Roth IRAs
There are all sorts of retirement accounts. Public school teachers might boost their retirement with a 403(b), and self-employed professionals could lower their tax burden with a SEP IRA, to name a couple of examples.
More likely, you’ve probably heard of these three common retirement savings vehicles:
- Traditional IRA
- Roth IRA
There are plenty of ways to save for retirement without an employer’s help. But if you’re choosing between IRAs — also known as individual retirement accounts — it’s important to know the differences.
A Roth IRA is unique from its peers because it’s a tax-advantaged account. That means you make contributions to it after they’ve been taxed, so you can withdraw what you put in without being taxed again. That’s the first and most obvious rule of Roth IRAs.
Because they’re tax-free, Roth IRAs aren’t tax-deductible. But they make wise savings vehicles for younger professionals. If you make less money now than you will in the future, you might as well invest while you’re in a lower tax bracket.
Before we get to Roth IRA withdrawal rules, let’s review some guidelines on contributions.
3 Roth IRA contribution rules
Even if you have an employer-managed 401(k), you also can contribute to a Roth IRA. In fact, you have 15 months to do it, from the beginning of the calendar year to the tax-filing deadline the following year (April 18 in 2018).
All you need to do is to earn a paycheck — and follow these three Roth IRA contribution rules.
1. You can contribute only so much
As has been the case since 2015, you can’t contribute more than $5,500 (or $6,500 if you’re 50 or older) to all your IRAs (Roth or Traditional) combined.
Say you contribute $4,000 to your Traditional IRA in 2017, for example. You wouldn’t be able to contribute more than $1,500 to your Roth IRA in the same year.
There’s a workaround if you bump up against your contribution limit, though. You could open a Spousal IRA. This account allows you to contribute from your paycheck to an IRA in your husband’s or wife’s name. And hey — you could make yourself the primary beneficiary.
2. Your income affects your contribution limit
If you earn an income of less than six figures, you have nothing to worry about. But if you take home a bigger paycheck, your Roth IRA contribution limits are reduced and might disappear altogether.
Single tax filers earning less than $120,000 and joint tax filers raking in less than $189,000 could max out at $5,500 in contributions, according to the IRS’ 2018 limits.
If you’re a single tax filer and you earn between $120,000 and $135,000, however, your contribution limit will be reduced. And if you earn more than $135,000, you wouldn’t be able to make any Roth IRA contributions.
If you earn too large of a salary to contribute to a Roth IRA, you could store some of it in a Traditional IRA, which doesn’t have an income restriction.
3. You could score a tax credit for contributing
Unlike other Roth IRA rules, this one is 100 percent positive.
Although you can’t deduct your Roth IRA contributions from your taxes, you could earn a saver’s credit from the IRS. You just need to be an independent adult. The lower your salary, the greater your tax credit could be.
If you and your spouse earn less than $37,000 combined in salary, you could receive a 50 percent tax credit on your Roth IRA contributions. Say you threw $3,000 into your IRA. You’d be returned a credit of $1,500.
3 Roth IRA withdrawal rules
A Traditional IRA requires you to stop contributing and start making withdrawals when you reach the six-month mark following your 70th birthday. But a Roth IRA allows you to withdraw your contributions at any age.
Here are three more Roth IRA distribution rules that have positive and negative consequences.
1. You could be penalized and taxed for withdrawing too early
First among Roth IRA withdrawal rules: You can’t take out the whole balance without facing a fee.
Yes, your post-tax contributions can be removed tax-free at any time. But if you start accessing your account’s earnings before you turn 59 and a half, you could face a 10 percent penalty for the early withdrawal. It’s a retirement account, after all.
If you can wait until closer to your 60th birthday, you could withdraw both your post-tax contributions and your pre-tax earnings without paying a dime in fees.
There are some exceptions to the “59 and a half rule.” The IRS forgives the 10 percent early withdrawal penalty in specific cases, including to:
- Pay for your or a family member’s higher education
- Cover medical expenses that are at least 10 percent of your income
- Buy, build, or rebuild your family’s first home
2. You have to follow the five-year rule
Regardless of your age, you need to have contributed to your Roth IRA for at least five years before making a withdrawal. Otherwise, you’d incur the penalty.
If you opened a Roth IRA when you turned 59, for example, you couldn’t make a withdrawal when you’re 59 and a half. You’d need to wait half a decade — until your 64th birthday — to avoid the 10 percent penalty.
In this way, a Roth IRA is a lot like saving up using a certificate of deposit. Your money will grow if you hand it over for a specific period. But you can’t access the funds until the five years are up.
3. You can leave the account untouched and pass it on
Among the most important Roth IRA rules is that you can let your money grow in the account as long as you want.
This rule makes Roth IRAs different from Traditional IRAs, which come with required minimum distributions (RMDs) starting at age 70 and a half.
Another benefit is that if your Roth IRA account outlives you, the balance will shift to your heirs. Plus, they wouldn’t have to pay taxes to dip into it.
The last Roth IRA rule
Don’t forget that Roth IRA rules are shaped by tax law. A fluid federal government makes for a fluid IRS, and these rules could change for better or for worse.
So beyond the six must-know rules, there’s actually a seventh rule to follow: Stay up to date on the rulebook. Knowing how to make the most of your Roth IRA puts you in the best position to manage your financial future.