Nearly anyone can benefit from Roth IRAs
In last week’s Business Outlook, part one of this article appeared. It covered the history of traditional IRAs and Roth IRAs, contributing to a Roth IRA, contributing to a Roth 401(k) or Roth 403(b), and converting a traditional IRA to a Roth IRA.
If you would like a copy of the full article, please email dscygan@sagefuture.com.
The five-year rules
The contributions you make to a Roth IRA can be withdrawn with no penalty at any time and at any age.
This is because there was no tax benefit on the front end. However, the earnings must be left in the account for at least five years and until the person is age 59.5. There are exceptions (death or disability, qualified first-time homebuyers, higher education, and to pay health insurance premiums for unemployed persons). The five years starts on Jan. 1 of the year of the first contribution. Contributions in later years do not start another five years.
The five-year rule is different for Roth conversions. In that case, the clock starts ticking for five years with each conversion. If you convert in October 2020, your five years began Jan. 1, 2020. If you convert more in 2021, another five years begins on Jan. 1, 2021. The IRS has ordering rules that stipulate that contributions are withdrawn first, followed by conversions, and then earnings.
Beneficiary changes
The SECURE Act that was passed in December 2019 stipulated that if a traditional IRA or Roth IRA is inherited by someone other than a spouse (after Dec. 31, 2019), the beneficiary must liquidate the account within 10 years.
This was a detrimental change for all the folks who were planning on passing traditional IRAs and Roth IRAs to children or grandchildren, and were looking forward to them being able to “stretch” the withdrawals over their lifetimes. Unfortunately, the inherited money must now be withdrawn within 10 years. This will cause some tax challenges for the beneficiaries of large traditional IRAs, because the withdrawals are all fully taxable as income. Roth IRAs must also be withdrawn within 10 years, but the Roth IRA withdrawals are tax-free.
Who benefits?
Roth IRAs are a great way to save for retirement, but they are also excellent for teenagers or college students with parttime jobs. Knowing that the contributions can be withdrawn at any time without penalty makes them attractive for all ages. And grandparents or parents can fund a Roth IRA for a teenager or college student, as long as the young person has earned income that is reported on a tax return.
Roth IRAs — and Roth 401(k)s and Roth 403(b)s — are great for anyone who appreciates tax-free growth and tax-free distributions. They can also help keep taxes low in retirement. For those who fret that our government may start taxing Roth IRAs in the future, this is possible. However, I think it is likely that accounts already established will be “grandfathered” (to keep them tax-free) if the rules change. As stated earlier, a Roth IRA is a powerful tool in an investor’s toolbox.
I encourage you to include a Roth IRA in your investment portfolio.