All About Roth IRAs

If you have even dipped a toe into the world of personal finance, you have probably heard of a Roth IRA. The actual logistics of using one, income/contribution limits, and tax ramifications can be somewhat confusing though. That’s why this post will be all about Roth IRAs, and although we can’t cover absolutely everything, we hope you will learn something useful for your own finances.

What is a Roth IRA?

Let’s first talk about what an IRA is. The acronym “IRA” stands for Individual Retirement Arrangement. It’s a financial account that provides tax benefits for retirement savings. In order to receive the tax benefits of these accounts, you have to wait until retirement age, which is 59 ½, to withdraw the money. A Roth IRA doesn’t give any immediate tax break when you put money into it. Income that is contributed to a Roth must be taxed first, but from then on, it’s 100% tax free as long as you follow proper distribution rules. This includes any interest you earn on the investments before you eventually take money out in retirement.

Example:

In 2024 you put $7,000 into a Roth IRA and 30 years later it had grown to be $70,000. By this time, you are 59 ½ years old and can take tax free withdrawals. Not only do you get your $7,000 back with no taxes, but you also get the $63,000 of growth with a tax bill of $0.

Who can use a Roth?

Although there are some strategies that higher income earners can use to accumulate Roth savings, there are limits on how much income you can bring in before you are restricted on direct Roth IRA contributions. These limits are based on your Modified Adjusted Gross Income (MAGI). In 2024 the limits where Roth Contributions start phasing out are as follows.

Contribution Limits

You are allowed to contribute up to $7,000 to a Roth IRA per person in 2024. Another requirement is that you have earned income, and your contributions cannot exceed that income. So, if you have a part-time job that pays you $6,000 a year, you can only contribute $6,000 for that year. If you are age 50 or older, you can contribute an additional $1,000 for a total limit of $8,000 in 2024. This is called a “catch-up contribution” and allows for those approaching retirement to accelerate their savings.

Benefits

Reduce/Remove Tax Expense

There is a reason why so many in the personal finance world rave about Roth IRAs. Tax free growth and income in retirement means you don’t need to worry about the extra expense of taxes. Increasing costs like health and long-term care are enough to have on your plate without worrying about setting money aside for taxes.

More Flexible Retirement Spending

We have plenty of clients that worked hard to save money in their traditional IRAs, but when it comes time to start spending it, they are afraid to pay taxes for taking it out. As a result, they live below their potential in retirement. With a Roth IRA, taxes won’t deter you from spending your savings how and when you want to. You have total flexibility to withdraw as much or little as you want with no tax consequences.

Pay the Devil You Know

There is a constant debate about Traditional vs. Roth IRAs, and which is better. The truth is, there is no easy answer to that question, but another benefit of Roth contributions is that you know what the tax rate will be on the money you put in. On the other hand, with a traditional IRA, because of shifting politics and tax legislation, you don’t really know what the tax rate will be by the time you retire and withdraw money from it. That uncertainty is the reason why many people prefer to pay the devil they know with a Roth IRA, rather than the devil they don’t.

Tax Free Inheritance

The last benefit we will mention is the ability to pass on tax free assets to your heirs. Traditional IRAs that are inherited by children or other loved ones can be significantly reduced by taxes. Roth IRAs pass to a beneficiary tax free, regardless of the income of the heir. This allows your loved ones to keep their entire inheritance and not worry about dealing with taxes after you have passed

Things to keep in mind

Although we have a lot of love for Roth IRAs, we also want to include two important things to consider before getting started.

First, a Roth IRA isn’t a one size fits all solution. Things like income, tax brackets, and other circumstances may make Roth contributions a poor choice for your financial plan. These factors should all be considered before you decide which IRA type to use.

You may have also found yourself thinking… that’s a lot of rules and limits to keep straight. You’re right, and that’s why we recommend working with one or more professionals to create a retirement savings plan that fits your needs. A financial advisor like 3 Peaks Financial can be a fantastic resource to help you set up an IRA and determine how to maximize your retirement income. In addition, a CPA or tax professional can help make sure you are eligible to contribute and assist in tax preparation.

Building a team of professionals is often the best strategy to make sure you don’t miss any part of your financial preparation. If you have questions about IRAs, your retirement plan, or anything financial, give us a call today or book a free consultation by clicking “Schedule Appointment” in the top right corner.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing includes risks, including fluctuating prices and loss of principal.

3 Peaks Financial does not provide tax or legal advice. Please consult a tax professional before implementing information or strategies found in this publication.

*Connor Dye is solely an investment advisor representative of 3 Peaks Financial Advisors, and not affiliated with LPL Financial.