The benefits of beneficiary planning
Learn the importance of naming a beneficiary on your retirement accounts.
Learn the importance of naming a beneficiary on your retirement accounts.
05/21/2024
RETIREMENT PLANNING
Read the summary of benefits of a Roth IRA here – or scroll down to read the full article.
Roth IRAs (Individual Retirement Accounts) are often touted for their tax-advantaged retirement savings benefits, but your Roth IRA can also serve as a financial resource beyond retirement savings.
You can use a Roth IRA to help pay college expenses, to make a down payment for a home, or to serve as an emergency fund. But the primary benefit of a Roth IRA is the contributions you make grow tax deferred.
When you take a withdrawal, contributions come out first, and can come out anytime for any reason, tax and penalty free. Conversions and rollovers are next with the taxable portion coming out first followed by the non-taxable portion. Earnings are withdrawn last.
Earnings may be subject to tax and penalty unless the distribution meets the definition of a “qualified withdrawal.” To be a qualified withdrawal, you must have made your first contribution or conversion to the Roth IRA at least five years prior, and the distribution must meet one of these four requirements: Over age 59 ½, disability, first time home buyer’s exception (up to $10,000), distributions to a beneficiary after your death. Learn more about qualified withdrawals
For example, if you are age 50, you’ve contributed $50,000 to a Roth IRA, and you’ve earned $20,000 in investment returns, you could withdraw up to $50,000 without tax or penalty. You would be taxed and possibly subject to an early withdrawal penalty on any withdrawals beyond that unless it was a “qualified withdrawal.”
It’s also important to understand that these withdrawals are not considered loans. However, if you find that you don’t need the withdrawal, you will have 60 days from the date of the distribution to roll the dollars back into the original Roth IRA or over to another Roth account under your name. You are only allowed one rollover in a 12-month period for all IRAs that you own.
Many parents set up 529 or Coverdell Educational Savings plans to help fund college costs, but there may be advantages to using a Roth IRA for the same purpose. For instance, you could withdraw your contributions (the principal), for this purpose.
In addition, if you also withdrew the earnings, you would be subject to income tax on the earnings, but the 10% early withdrawal penalty doesn’t apply because qualified higher education expense is a penalty exception. Qualified educational expenses include such costs as tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.
However, because of the contribution limitations of a Roth IRA, you may not be able to put away enough money to cover four years of college costs. On the other hand, most 529 plans have contribution limits well more than $300,000, giving contributors the ability to cover most, if not all, of their child’s college costs. (See: How to Choose a 529 Educational Savings Plan)
With 529 plans, if your child doesn’t use the money for education – and you don’t have another qualified family member to transfer the 529 funds to – once you start withdrawing the funds, you would typically be responsible for paying income taxes on the investment gains within the account, and you would be assessed an additional 10% penalty tax on the earnings for using your 529 savings for non-qualified expenditures.
With a Roth IRA, if your child doesn’t need funding for higher education, you can keep the money in the account until you’re ready to withdraw it.
If you would like to buy a home, you may consider using your IRA as a source for part of the down payment. First time home buyers – defined as those who have never owned a home or have not had a financial interest in a home during the past two years – have a one-time option to withdraw up to $10,000 from an IRA to use as a down payment without penalty. Your spouse can also withdraw up to $10,000 from his or her IRA for the down payment.
Roth IRA holders can withdraw the money they’ve contributed tax and penalty-free. In addition, if it’s been at least five years since the first contribution or conversion to your Roth IRA, a distribution of earnings, up to $10,000 as a first-time home purchase, is considered a “qualified distribution” from the Roth and is not subject to tax or penalty. If it has not been five years since your first contribution to the Roth IRA, then the distribution is not a “qualified distribution” and the earnings would be subject to income tax, but not subject to the 10% early withdrawal penalty. Read Avoiding Tax Penalties on IRAs for details.
Since you can withdraw your contributions from your Roth IRA at any time without tax or penalty, a Roth IRA can be used as a back-up fund to cover unexpected costs, such as medical care, costly repairs, and family emergencies.
Here are some of the most important rules and contribution limits to help you get the most out of your Roth IRA. Visit IRS.gov for more details.
1. For a Roth IRA, single filers must have a Modified Adjusted Gross Income (MAGI) under $138,000 for the 2023 tax year and under $146,000 for 2024. Contributions would be reduced on a sliding scale between $138,000 and $153,000 for 2023 and between $146,000 and $161,000 for 2024.
2. Married couples filing jointly must have MAGI between $218,000 and $228,000 in 2023 and between $230,000 and $240,000 in 2024 to qualify for a Roth IRA, with contributions reduced on a sliding scale. See more on Roth IRA income restrictions
The information provided is not intended as a source for tax, legal or accounting advice. Please consult with a legal and/or tax professional for specific information regarding your individual situation.
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