Much has been made of the Roth IRA and its less well known cousin the Roth 401k, but not many have taken advantage of it. That is a shame.
The main obstacle is access – for many, their current income limits their ability to contribute. Those making over $118,000 for individuals and $186,000 jointly are limited or ineligible to contribute. But don’t stop reading if you make more than that – there are many reasons and ways to get a Roth.
For starters, distributions from a Roth IRA are not taxable. (Individual state tax laws may vary). Setting aside the obvious benefit, this has important implications. First there are no required minimum distributions (RMD) because contributions going into the Roth have already been taxed.
For most households, the majority of savings are in tax-deferred vehicles like a traditional IRA or 401k. Once you reach age 70 and a half, you are required to take a minimum amount out of your deferred accounts. For some, that is a considerable amount, which will drive up reportable income, at ordinary income rates.
Consider the impact if you are using MediCare Part B. The premium you pay is based on your income, and starts at $134 per month. With enough income, the premium goes up to $428 per month. That is a big swing in cost.
Additional taxable income can get you closer to the income tax surcharge now in effect. The income tax surcharge activates on annual income levels above $250,000 for a couple and can be as high as 3.8%. There are also deduction phase-outs and personal exemption phase-outs at higher levels of income. If income is coming from a Roth, you may not hit those levels.
Could this all change with a new tax plan? Sure. But it hasn’t yet and planning ahead can only help you.
So, how do you get a Roth IRA if you are above the annual income limits?
One way is to check to see if your 401(k) retirement plan has a Roth contribution feature. Anyone at any income level can deposit plan contributions into a Roth option but only if your retirement plan includes the option. If it doesn’t, ask your employer for it. When the time comes to leave your 401K plan, all Roth money can roll into an individual Roth IRA. You cannot get the upfront income tax deduction but your money grows tax-free and distributions are tax-free.
Another option is to convert some or all of your traditional IRA to a Roth IRA. If your income is lower in any given year, or you have room before hitting the next marginal tax rate, it may be time to convert as much of a traditional IRA to a Roth as possible. Yes, you incur the taxes today, but you have all the benefits later.
These are just some of the benefits of a Roth IRA or Roth 401(k) plan , there are more.