Roth IRA: Tax-Free Income in Retirement

Shawn Plummer

CEO, The Annuity Expert

A Roth IRA is a retirement account that allows you to save money and grow your personal wealth tax-free. With the money you contribute, the government will not take taxes from it when you withdraw funds in retirement. We’ll go over everything an account holder needs to know about Roth IRA rules in this post!

What is a Roth IRA?

Roth individual retirement accounts (IRA) are financial products for U.S. residents, paid with after-tax dollars. A Roth IRA owner can make money without paying taxes on it. It was named after William Roth, a former Delaware Senator.

You can put money into these investment vehicles with your own money. It is not tax-deductible, but it will be free from taxes when you take the money out of the account.

If you work, you can put earned income into your retirement account.

Roth IRA Contribution Limits

In 2021, the annual contributions limit is $6,000 a year. People who are 50 or older can deposit up to $7,000 in Roth IRA contributions.

Who can not contribute to a Roth IRA?

There are income limits to participate in this retirement plan. The annual contribution limit is no more than $140,000 a year in gross income as an individual, or if a married couple makes more than $208,000 a year together, then the joint filer cannot contribute to a Roth IRA.

If you do not receive earned income, you can not contribute to a Roth IRA.

Required Minimum Distributions (RMD)

There are no required minimum distributions (RMD) if you invest in a Roth.

How To Open A Roth IRA

A Roth IRA account must be created with a company that the IRS approves. This includes banks, brokerage companies, federally insured credit unions, insurance companies, financial institutions, and savings and loans. Financial advisors typically set up the accounts.

You can open a Roth at any time. But you have to do it before the owner’s tax filing deadline, which is usually April 15th of the following calendar year. You cannot get an extension.

What Type Of Money Can Be Contributed

Only earned income can be contributed to a Roth savings account.

W-2 Employees

If you are a W-2 employee, the money you make from your job can pay for a Roth IRA. Things like wages, salaries, commissions, and bonuses can all count.

Self-Employed

If you are self-employed, compensation is the individual’s net earnings from their business, less any deduction allowed for contributions made to retirement plans on the individual’s behalf, and further reduced by 50% of the individual’s self-employment taxes.

Divorce

Money related to divorce can also be contributed. This is called alimony. Child support or money from a settlement can also be put in the account too.

What Type of Money Can Not Be Contributed

The IRS limits the type of contributions that can be made to a Roth. These income sources are prohibited:

Spousal Roth IRA

A married partner can fund their spouse’s Roth account. It doesn’t matter what their income is. Spousal Roth IRAs are the same as regular Roth IRAs, but they must be held separately from each other’s accounts.

Eligibility

  • Married and file taxes jointly.
  • The individual making contributions must use earned income.
  • Make less than $208,000 as a household.

Distributions

Qualified Distributions

You can take out your own money from a Roth IRA without any taxes or penalties. If you only take out what you put in, the retirement savings is not taxable, and there are no penalties. This is known as a qualified distribution.

If you have a Roth account, and you want to get the money out of it penalty-free when you are older, then it must happen at least five years after the first time you put money in. To receive tax-free withdrawals, the money has to come out under one of these conditions:

  • Owners are at least 59½ when they take money out of their Roth IRA.
  • The distributed assets must be used to buy, build, or rebuild a first home. This can only happen for $10,000 per lifetime.
  • The distribution of a person’s Roth IRA can happen after they become disabled.
  • The beneficiary of a Roth IRA owner’s account will get the money after that person dies.

5-Year Rule

When you withdraw money from your account, it may be taxed. The percentage that it will be taxable income depends on how old you are. If you have met the 5-year rule, there is no tax or penalty when withdrawing your account.

You’ve waited at least 5 years:
  • Younger than age 59½: Earnings are taxed and penalized by 10% (Early Withdrawal Penalty). If you use the money to buy your first home, you can avoid taxes and penalties. You can also avoid taxes if you have a disability or if you die.
  • Age 59½ and older: No taxes. No penalties.
You have not waited for at least 5-years:
  • Younger than age 59½: Earnings are taxable compensation and penalized by 10% (Early Withdrawal Penalty). If you use the money to buy your first home, you can avoid penalties. You can also avoid penalties if you have a disability, if you die, or use the withdrawal for qualified education expenses.
  • Age 59½ and older: You are paying the taxes but avoiding the penalties.

Non-Qualified Distributions

If you take money from your Roth account too early, you may have to pay tax and a 10% penalty. The exceptions are:

  • Unreimbursed medical expenses. If you use the money to pay for medical bills that are more than 10% of what you make in a year, then it is okay.
  • If someone has lost their job, they might need to pay for their medical insurance.
  • The withdrawal is used for qualified higher-education expenses. This includes tuition, fees, books, supplies, and equipment required for enrollment or attendance.
  • You can get up to $5,000 for your pregnancy or adoption if you withdrawal within 1 year of giving birth or adopting.

Roth Conversion

A Roth IRA conversion allows IRA owners to convert their traditional IRAs into Roth IRA accounts. This allows investors to:

  • Pay the ordinary income tax now on their tax-deferred savings, and earn interest tax-free going forward.
  • Receive tax-free income when they retire.
  • Withdraw their contributions at any time, tax-free.
  • Avoid required minimum distributions (RMD) in the future.

Guaranteeing A Tax-Free Income For Life

Once the Roth IRA requirements are met, an owner can transfer their account into a Roth annuity with a lifetime income rider. The annuity will then distribute a tax-free income for the rest of the retiree’s lifetime or married retirees’ lifetimes, even after the Roth IRA has run out of money. The Roth IRA annuity is a great way to layer retirement income in addition to Social Security income while protecting against market volatility.

Younger investors can contribute to a new Roth IRA annuity for tax-free growth or convert their traditional IRAs into a Roth IRA annuity and guarantee their future tax-free income during retirement as well. Eligible individuals should contribute as much money as possible to the savings account before traditional IRA contributions are made.

Frequently Asked Questions

Can a Roth IRA lose money?

A Roth IRA can lose money if the account is set up traditionally with investment options. A Roth IRA can not lose money if the account is set up as a fixed or fixed index annuity.

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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