What to Know About Roth IRAs

When I first started at Nestlerode in 1992, the only option for a qualified retirement account was traditional, tax deductible for money being contributed. Money going into the typical retirement was deducted from taxes and taxes were owed on the distributions in retirement. In 1998, U.S. Sen. Will Roth of Delaware proposed the idea of a Roth IRA, where money going in was taxed but all earnings were tax-free and qualified distributions were tax-free in retirement.

Both types of individual retirement accounts have similarities. The limits are the same for both, for 2024, the maximum contribution is $7,000 with an additional $1,000 permitted for those age 50 or older. Money from both accounts can be taken after age 59 1/2 without penalty. A Roth must also be open at least five years for penalty-free withdrawals.

Participants must have earned income (from working) to make contributions to any retirement account. There are additional limitations on who can contribute to either type of IRA. For a Roth in 2024, you can make a full contribution if your Modified Adjusted Gross Income (MAGI) is under $230,000 for married couples filing jointly or $146,000 for single filers. For a traditional IRA, an employee can make deductible contributions if they do not have an employer plan (401k, etc.). If an employee is eligible for their employer plan, they can still make maximum deductible IRA contributions if their MAGI is under $123,000 if they are married filing jointly and under $77,000 for single filers. Contributions and MAGI limitations usually increase annually.

For high-income couples and individuals, the options outside of an employer plan are limited. That brings me to a loophole. First, note that anyone can make a non-deductible contribution to a traditional IRA. There is also the option to convert IRA assets to a Roth. Typically, converting assets from an IRA to a Roth causes taxes on the assets that are moved. However, considering the money that just went into the traditional IRA was after tax, the contribution can then be converted into the Roth without tax.

If the individual is under age 59 1⁄2, the 10% penalty for early withdrawal does not apply if the transaction was due to a conversion. There is a five-year rule. If the person withdraws funds from the Roth within five years of the conversion and before age 59 1⁄2, the amount of the conversion principal you withdraw will be subject to the early withdraw penalty of 10%. The five-year wait starts on January 1 of the year of the conversion and is applied to each Roth conversion individually.

The question you may be asking is which option is better? As with most financial questions, the answer is a personal one.

For young workers who are not making much money, a Roth option in a 401k or an Individual Roth account makes sense. They have a long time for growth, which is not taxed in retirement. It may make sense for a retiree, who does not want to take a RMD at age 73 and wants to keep the retirement assets for later, to convert traditional retirement assets. A Roth IRA does not require minimum distributions.

The best advice is to look at your situation and see what makes sense for you. Like diversification with investments, I believe tax options in retirement (taking tax-free distributions or taxable) can be advantageous. Consult with an advisor on what is best for your situation each year.

All investing is subject to risk, including possible loss of the money you invest. Nothing in this article should be construed as investment or retirement advice. Always consult with a professional advisor and consider your risk tolerance and time to invest when making investment decisions. Review your personal situation with a professional before planning any gifting or estate planning.

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