Retirement is one of those life stages that you can find yourself suddenly having to make some big decisions. How much money you will have can be a determining factor in where you end up living, whether you will need to work part-time, how much money you have in your monthly budget and other important questions. That's why it's never too early to start saving for your retirement.
But where do you start and what do you need to know? A Roth IRA is one of the most popular options out there and is a great place to start saving for retirement. However, figuring out all the Roth IRA rules can be a bit tricky. Luckily, we're here to break it all down.
What is a Roth IRA?
With a Roth IRA, your investment grows tax-free and you can make withdrawals when you retire without having to pay taxes. This is because your contributions to your Roth IRA are made with money that you have already paid taxes on. So if you expect your tax rate to be higher in the future than it is now, a Roth IRA is your best bet.
Aside from the tax benefits, there's more to love about Roth IRAs. They're flexible so you don't have a minimum age requirement when you have to start taking out money. Traditional IRAs, on the other hand, require that you start taking minimum distributions once you are 70½ years old.
If you need access to your money before you reach the minimum 59½ years of age, it’s possible to not have to pay a penalty. That’s as long as the money is used for one of the reasons that falls under an exception.
13 Rules You Should Know About a Roth IRA
The benefits of a Roth IRA probably sound great to you... and they should! But these benefits don’t come without rules. Here are 13 rules that you should know about Roth IRAs in 2020.
1. Maximum Contribution Limit
First of all, there is a limit to how much you can contribute to your Roth IRA each year. Each year the IRS will review the outlook for inflation and adjust this amount. For 2020, the maximum contribution limit is $6,000 if you’re less than 50 years old.
Now, you need to keep in mind one other thing if you have both a Roth IRA and Traditional IRA. The amount that you contribute between these two accounts can't be more than $6,000 in total.
2. Catch-Up Contribution Limit
If you are 50 years old or more, you can make what the IRA calls a catch-up contribution. This is an extra amount above the maximum contribution limit of $6,000 that you can make to grow your retirement savings. This additional amount in 2020 is $1,000 for a total contribution of $7,000.
3. Employer-Plan Restrictions
You can have both a Roth IRA and an employer-sponsored retirement plan as long as you follow the contribution limits.
You might be familiar with 401(k), SEP, or SIMPLE IRA accounts. These are retirement plans that are sponsored by employers.
If you have a 401(k) or another type of employer-sponsored plan, you can contribute up to $19,500 per year if you are less than 50 years old. There’s an extra $6,500 of catch-up contribution if you are 50 years or older.
4. Maximum Income Limits
Your income must fall under a certain amount to be able to contribute to a Roth IRA. This is where a Roth IRA differs from a Traditional IRA, which doesn’t have an income limit.
The table below will break down these income limits for Roth IRAs in 2020. According to the IRS:
Your Tax Filing Status
Single (head of household or married couples filing separately)
$6,000 or $7,000 (if 50 years old or older)
$124,000 to $138,999
$137,000 or more
Married filing jointly or qualifying widow(er)
$6,000 per individual or $7,000 (if 50 years old or older)
$196,000 to $205,999
Married filing separately (at some point during the tax year, lived with a spouse)
$10,000 or more
5. You Can Get Around Income Limits With a Backdoor IRA
There is a way to get around these income limits if you make too much money. How it works is that you open and fund a Traditional IRA account. Then you turnaround and convert it to a Roth IRA. This type of workaround is called a backdoor IRA.
Since you don't pay taxes upfront on contributions to a Traditional IRA, keep in mind that means you'll owe taxes on the amount you convert. That also means that any gains from investments in your Traditional IRA are also subject to taxes.
A backdoor Roth IRA is not a simple process. There are also some serious tax consequences to opening one. That is why you should talk to a tax professional first before considering a backdoor Roth IRA.
6. Age Limit
Unlike Traditional IRAs which don’t allow you to make contributions after reaching 70½ years old, there is no age limit on a Roth IRA.
As long as you are earning income that qualifies, you can continue putting money into your account. Taxable income sources like a salary or hourly wage will allow you to continue contributing to your Roth IRA.
7. You Can Fund a Roth IRA on Behalf of Your Spouse
If your spouse isn't employed but you want to build up your nest egg together, there is an exception for married couples. To qualify, the working spouse who is eligible for IRA contributions must:
1. File jointly with their spouse on their income-taxes
2. Have eligible income such as salaries, wages, commissions, etc. that covers their IRA contribution and the total amount of their spousal IRA contribution
The IRA accounts must also be held separately from one another. The contribution and eligibility requirements are still the same for the Roth IRA (or Traditional IRA if that type of account is used).
8. You Can Access Your Contributions at Any Time
The money that you put into your Roth IRA has already been taxed. That means that the money is yours anytime you want it. Although, you cannot withdraw any capital gains without penalty until age 59½.
However, since the purpose of a Roth IRA is to help support your everyday expenses when you retire, it is probably best to leave your money alone. For emergencies, consider starting an emergency fund separately that can cover at least a few months of your expenses.
9. You Cannot Withdraw Your Earnings Before Age 59 ½
If you do withdraw your earnings before you are at least 59½ years old, then you will face a 10 percent penalty from the IRS and may owe income taxes. If you have had your account open for at least five years and you decide to withdraw your earnings, you don’t have to pay taxes because of the five-year rule.
You aren’t penalized for withdrawing your contributions before reaching the minimum age. Therefore if you must take out money from your Roth IRA, you should take it out from your contributions first.
10. Exceptions (To the above rule)
Luckily there are some ways that you can withdraw your Roth IRA earnings without being subject to a penalty or tax. These exceptions include:
• For a first-time home purchase (can withdraw up to $10,000 as long as you’ve had the account for five years)
• Certain education expenses for either yourself or a family member
• Medical expenses that are more than 10 percent of your adjusted gross income
• For health insurance premiums if you are unemployed
11. If You Have Taxable Income, You Can Make Contributions Forever
As discussed before, you can continue to make contributions to your Roth IRA for as long as you have taxable income. This could be particularly appealing if you want to leave your dependents with some of the funds from the account.
12. There is No Required Minimum Distribution
If you don’t want to withdraw any money from your Roth IRA, you are free to make that choice. One thing to note is that if you leave your Roth IRA to anyone other than your spouse, that person will have to take distributions at some point.
13. No Taxes For Your Beneficiaries
All the money that you contribute to your Roth IRA has grown with after-tax dollars. So if you decide to pass your Roth IRA to others upon your death, the money can be accessed tax-free.
About the Author
Anjana Paul is a banking professional who is passionate about helping others make better choices when it comes to money. In her spare time she is a freelance writer with years of expertise in the financial industry. She primarily writes about topics such as student loans, building credit, budgeting, retirement and other personal finance topics.