Ultimate Guide To The Roth IRA

I opened my first Roth IRA when I was in college, earning a few dollars doing odd-jobs over the summer working at my family’s sign manufacturing business, Pride Neon Signs. My parents educated me from a young age the importance of saving some of your hard earned money for retirement. Therefore, with some of my first earnings, I opened a Roth IRA with regular monthly savings of $50 per month. This got me in the habit of regularly saving, which in a way provided me the opportunity to start my own business, Lyndale Financial.

I haven’t done any scientific research, but it is my guess that the Roth IRA is the most popular investment account. After all, it is a retirement account that you can open at any age and on your own - you don’t even need to be employed! Some employers don’t allow you to participate in the company sponsored retirement plan (401(k)) until you’ve been working for a year, so the Roth IRA is where many turn to next.

Why is the Roth IRA so popular? We will get into the nitty gritty details below, but just know that it is an investment account with a low barrier to entry, great tax benefits, and can be used for a number of different financial goals.

Tax Benefits

To fully understand a Roth IRA, it is important to know the tax benefits. After all, this is the most important aspect of any retirement account.

When you receive income, you pay income tax on those dollars. After you’ve paid income tax, you are now able to contribute those dollars to your Roth IRA.

After making your Roth IRA contribution, the dollars may be invested in a wide variety of ways - stocks, bonds, mutual funds, ETFs, real estate, etc. As these investments grow in value over time, you are not required to pay any tax on the growth or income. This means that assets inside a Roth IRA receive tax-deferred treatment.

When it comes time to withdraw money from your Roth IRA in retirement, all of your contributions and growth of the investments are received tax-free. This means that the only tax you paid on these dollars over their lifetime is on the actual contributions you made years ago.

These are the three main points to understand - after-tax contribution, tax-deferred growth, and tax-free withdrawals. There are other considerations that will be discussed later.

Eligibility

Anybody with earned income is eligible to open and contribute to a Roth IRA. It doesn’t matter if you’re two years old or 100. The only downside to the Roth IRA is the low contribution limit of $5,500 per year ($6,500 for ages 50 and older), compared to other retirement accounts.

The main consideration for eligibility is your income level (modified adjusted gross income, specifically), which is measured according to your tax-filing status (Single or Married Filing Jointly).

Single:

  • Income up to $118,000 can contribute the full $5,500
  • Income between $118,000 and $133,000 is in the phase-out range
  • Income above $133,000 cannot directly contribute to a Roth IRA

Married Filing Jointly:

  • Income up to $186,000 can contribute the full $5,500 (each)
  • Income between $186,000 and $196,000 is in the phase-out range
  • Income above $196,000 cannot directly contribute to a Roth IRA

For those with income levels that land in the phase-out range, you will still be able to contribute, albeit at a reduced level. For example, if you are a Single filer and earn $125,000, you will be able to make a maximum contribution of $2,933.33 in 2017.

Flexibility

One of the better aspects of the Roth IRA, compared to any other retirement account, is its’ flexibility. When you make a contribution to your Roth IRA, you can withdraw that contribution at any time, without any penalty or tax. This means if you make a $100 contribution to your Roth IRA today, you can take out that same $100 tomorrow, worry-free.

Looking further down the road, you are able to withdraw any money from your Roth IRA (contributions & earnings), once you’ve had the account open for 5 years and reach age 59 ½. Furthermore, there are no mandatory withdrawals in the Roth IRA, meaning you can keep your dollars invested in the tax-deferred account as long as you wish.

Do you want to use your Roth IRA to purchase your first home? If you’ve had your account open for five years, you can withdraw up to $10,000 penalty and tax-free for a first-time home purchase. This includes money needed for the down payment and closing costs.

Another benefit to the Roth IRA is the contribution deadline. You are able to make your annual contribution anytime before you file your taxes the following year. For example, you have until April 18, 2018 to make your 2017 Roth IRA contribution. This gives you additional time to see if you’re eligible (due to income level) or additional time to save up, if you haven’t maxed out your annual contribution yet.

And finally, here are a few more ways you can use the Roth IRA, if needed:

 

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