RETIREMENT PLANNING

Read the summary of benefits of a Roth IRA here – or scroll down to read the full article.

• Tax considerations with a Roth IRA
• College funding with a Roth IRA
• Buying a home with a Roth IRA
• Emergency fund with a Roth IRA
• Contribution rules and limits with a Roth IRA

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 Earnings are withdrawn last.

Tax considerations

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. 

College funding

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.

Buying a home

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.

Emergency fund

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.

Roth IRA contribution rules and limits

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.

• Contribution limits
  For the 2023 tax year, you can contribute the lesser of $6,500 or your earned income, and for 2024, you can contribute $7,000. If you’re 50 or over, you can contribute a total of $7,500 (or up to your earned income) for 2023 and  $8,000 for 2024. If you contribute to both a traditional and a Roth IRA, your total contributions cannot exceed your contribution limit.

• Spouse contributions
  Your spouse can also contribute if you have sufficient combined earned income. For instance, if you’re both under 50, you and your spouse could each contribute up to $6,500 for the 2023 tax year or $7,000 for 2024 if your combined earned income is at least $13,000 in 2023 or $14,000 for 2024. (If you’re both over 50, the higher limits  would apply.)

• Age restrictions
  Roth IRAs have no age restrictions for contributions. You are not required to take withdrawals from your Roth IRA during your lifetime. Spouse beneficiaries may roll into your own IRA or begin taking RMDs no later than December 31 of the year following the owner's death, based on your single life expectancy. Generally a non-spouse beneficiary must distribute the full inherited Roth IRA by December 31 of the tenth year following the year of the owner’s death.

• Higher income restrictions
  There are income restrictions to be eligible to contribute to a Roth IRA:

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

• When to make contributions
  Contributions can be made to your Roth IRA at any time during the calendar year, and as late as the due date for filing your tax return (which is usually on or around April 15 of the following year). (See: Saving to your IRA now could make a big difference later)

• Contributions: Lump sum or throughout the year?
  You can make contributions as a lump sum, or periodically. You can also set up an automatic purchase plan that withdraws a set amount of money each month from your bank account and invests it in the mutual fund or funds of your choice within your IRA account.

• Conversions
  Conversions are subject to penalty if withdrawn the earlier of 5 years since the conversion or one of the IRS penalty exception applies.

• 401(k) plan
  If you already have a (401k) plan or another type of retirement plan at work (such as a pension, profit-sharing SIMPLE or SEP plan), you can contribute to a Roth IRA if you are under the income ceiling.