If you’re looking to learn the Roth IRA definition along with many frequently asked questions about Roth IRAs, this is the resource for you. In this article, we will detail Roth IRA contribution limits, key terms to remember, and a plethora of other must-know rules and regulations.
Roth IRA Definition | Understand The Basics
What Is a Roth IRA?
Named after Delaware Senator William Roth, it was established through the Taxpayer Relief Act of 1997. The Roth IRA is a special type of individual retirement account (IRA), made so that investors could contribute after-tax money into the account and withdraw later on tax-free returns.
What Are The Terms To Remember?
First and foremost, it is important to understand the most common terms you will encounter when researching Roth IRAs:
- Contribution Limit – The contribution limit refers to the maximum amount you can add to your Roth IRA account in any given year.
- Distribution – It refers to a withdrawal from your IRA account.
- Modified Adjusted Gross Income (MAGI) – This is the sum of your adjusted gross income (AGI) and any tax-exempt income you’ve generated. Your 1040 form will contain all the possible items you can add to your AGI in order to calculate your MAGI.
- Phase-Out – In order to make contributions to your Roth IRA, you have to make under a specified amount of money each year; the phase-out is the range of income just before the cut-off, within which you can make a reduced contribution. Once your income surpasses the phase-out range, you are no longer allowed to contribute to your Roth IRA for that given year.
- Filing Status – This is the status you indicate when you file a tax return. There are six options: single, head of household, married filing separately not having lived with your spouse, married filing separately having lived with your spouse, married filing jointly, and qualifying widow(er). Your filing status and your MAGI are the two variables that will determine how much money you can contribute to your Roth IRA annually.
- Roth IRA Conversions – Also referred to as backdoor IRA, this process allows you to convert other retirement investment plans (Traditional IRA, 401k) into your Roth IRA. Conversions are helpful when your annual earnings are more than the MAGI phase-out limits. Learn more about it here.
What Are The Benefits Of a Roth IRA?
One of the most common questions regarding Roth IRAs is why they are necessary when you might already have a Traditional IRA. Here are some of the key features that make Roth IRAs a valuable financial asset:
- It doesn’t have an age limit – Unlike a Traditional IRA, with which you can only make contributions until you’re 70.5 years old, a Roth IRA doesn’t have an age limit. Additionally, just like a Traditional IRA, the maximum annual contribution limit is increased by $1,000 once you reach 50 years old, which can greatly improve your post-tax returns.
- It doesn’t have a mandatory withdrawal — With a Traditional IRA, you have to make your first withdrawal as soon as you reach 70.5 years old. Such a rule does not exist for a Roth IRA; therefore, you can let it grow over time and then use it only when you absolutely have to for as long as you want to.
- The returns within the account grow tax-free – Since you must pay income taxes on money you contribute to your Roth IRA, subsequent earnings and withdrawals are not subject to taxation (if you follow the rules).
- A non-earning spouse can also open a Roth IRA account – This is another strategy in order to contribute to a Roth IRA when you’ve already reached your limit. To understand more about this, click this link.
Who Can Contribute to a Roth IRA?
Anyone who earns any form of income, regardless of age, can contribute to a Roth IRA. Because of this, children can have an open Roth IRA account, and they can contribute to it if they legitimately earn income — this means it cannot be money earned for washing dishes or cashing in a gift from the grandparents. Additionally, the account should be under the name of your child, but as the child’s parent, you can oversee the account.
How Much Can A Person Contribute?
Both Traditional and Roth IRA contribution limits are set annually by the IRS; however, the current maximum contribution has been the same for the last several years. The current contribution limit is $5,500 for those under 50 years old and $6,500 for those older than 50.
There is another important aspect to this contribution limit all investors should be aware of: Traditional and Roth IRAs have the same annual contribution limit; as an investor, you cannot treat these limits as separate. It doesn’t matter how you choose to divide and contribute money between accounts as long as you do not contribute more than the limit.
For instance, if you’re 20 years old, and you earn $50,000, you can contribute $2,500 to Roth IRA and $3,000 to traditional IRA.
In regard to those earning less than these maximum contribution limits, you are allowed to grow your account up to your total earnings for the year. For example, if a minor earns $500 selling newspapers, then that’s the maximum amount he or she can add to the Roth IRA account.
What Is The Phase-Out Range?
The phase-out range depends on the filing status and the income bracket. The new tax reforms have brought some minor changes to the limits. For those who are single filers, the phase-out limit is $120,000 to $134,000. For married filing jointly and qualified widow(er), it is $189,000 to $198,000. If you fall within this range, you can make a partial contribution. If you go beyond, you cannot contribute anymore.
A major benefit to owning both Traditional and Roth IRAs is having the option not to contribute to your Roth IRA for a certain period of time while your income is high. You can instead contribute to your Traditional IRA, which doesn’t have income limits (however, this may affect your eligibility in making tax deductions).
Where Can You Get A Roth IRA Account?
Roth IRA’s have increasingly grown in popularity, and you can now open an account at most financial institutions, including banks, brokerage firms, and oftentimes through your employer. Many of these options allow you to set up your account online; and with today’s technology, it is now a relatively quick, simple, secure process if you have the right documentation available.
How Many Accounts Can You Open?
Based on our Roth IRA definition, the goal is to raise funds for retirement, which is favorable for the government. Thus, it doesn’t limit you on how many accounts you wish to open. You can have as many as you want, but all of them are still under the same contribution limits if they’re under your name.
How Do You Fund A Roth IRA?
A Roth IRA account earns in different ways, and one of them is by compounding interest. How your account generates the returns is up to you — Roth IRAs can hold many different types of assets, including mutual funds, precious metals, stocks, real estate investment trusts, cryptocurrencies, etc.
If you plan to diversify your investment portfolio within your Roth IRA, it is crucial that that you work with a knowledgeable, customer-friendly, and committed professional. Depending on the investment portfolio, you can either grow your money fast or lose it just as quickly — a quality financial adviser will help you determine your investment appetite and risk profile.
When Can You Fund The Account?
You have the full tax year to do it. The tax filing date is generally around April 15 (it was April 17 for the 2017 tax year). If you’re building a fund for the tax return year 2018, you can save from April 19, 2018 to April 15, 2019.
Hopefully, this covers everything you wish to know about Roth IRAs and their basic definitions. With this information, you’re on your way toward a solid beginning with investing in Roth IRAs.
If there are further questions you want to be answered, or if there is any other information on the topic you are curious about, feel free ask in the comments section below!