Roth IRA to the rescue
Why it’s such a smart money move.
If you haven’t opened a Roth IRA account by now, you should. And that’s especially so if you’re young, in a low tax-bracket and expect to be in a higher one later in life – in retirement.
A Roth IRA is a retirement plan where you contribute after-tax dollars. Your money grows tax-free; and, generally, distributions are tax-free. To be sure, you won’t really know if you’ll be in a lower or higher tax bracket years from now.
But most advisers have this to say about Roth IRAs.
“The Roth is the second-best deal in the tax code,” says William Harris, a certified financial planner and retirement management adviser with WH Cornerstone Investments.
Health savings accounts, or HSAs, are the best deal, Harris says.
Thomas O’Connell, president of International Financial Advisory Group, agrees, noting that there are other types of Roths to consider as well.
“Roth-anything is a great first line of defense versus rising tax rates,” he says. “Most people are not aware that they probably have a Roth component in their 401(k), 403(b), 457, TSP and they should take advantage of it when available.”
It all sounds good on paper. But there’s plenty to learn before you open a Roth IRA (or Roth anything).
Roth contributions
According to O’Connell, the top benefits of contributing to a Roth IRA are that you pay tax today in a low-tax environment and you have access to some of your money later on without penalties, under certain conditions.
For 2019, your total contributions to all your traditional and Roth IRAs cannot be more than $6,000 ($7,000 if you’re age 50 or older), or your taxable compensation for the year if your compensation was less than this dollar limit. Note, however, that your Roth IRA contribution might be limited based on your filing status and income.
Some married couples might also consider funding a spousal Roth IRA, Harris says. “Generally, you need earned income to contribute, but for married couples, there is an exception for a stayat-home spouse,” he says.
Distributions
Distributions from a Roth IRA are tax-free – that is, not included in the account owner’s gross income – if it’s a qualified distribution or if it’s a return of the owner’s contribution.
That’s one big benefit, O’Connell says. The other, he says, is that the original Roth IRA account owner doesn’t have to take distributions – ever.
A qualified distribution is one that meets two tests: The distribution has to be made after a taxable five-year period, and it must satisfy one of the following requirements: It is made on or after the date on which the account owner turns 591⁄2; it is made to a beneficiary or estate of the owner on or after the date of the owner’s death; it is a result of the account owner being disabled; or it is used for a first-time home purchase (though there’s a lifetime cap of $10,000).
By the way, beneficiaries of Roth IRAs have to wait only until the end of the original taxable five-year period for the distribution to be a qualified distribution.
Inherited Roth IRAs
What happens if you inherit a Roth IRA? If you’re a non-spouse beneficiary, you have to start taking distributions no later than the year following the death of the Roth IRA owner. The good news?
“The assets continue to grow untaxed, you can change your own beneficiaries, and withdrawals are tax free,” says Harris.
O’Connell notes too that non-spouse beneficiary Roth IRA accounts have the “potential to provide multigenerational tax-free income.”
If, however, you’re a spouse beneficiary, you’ve got two options. You can elect to be treated as the beneficiary or the owner of the Roth IRA. If you choose to be treated as the beneficiary, you can defer distributions until the year the original owner would have turned 701⁄2. If you choose to be treated as the owner, then you don’t have to take any required minimum distributions over your lifetime.
“If you treat it as your own, the five-year aging requirement and over age 591⁄2 or dead rules may apply,” Harris says.
Robert Powell is the editor of TheStreet’s Retirement Daily – www .retirement.thestreet.com – and contributes regularly to USA TODAY. Got questions about money? Email Bob at rpowell@allthingsretirement.com.