Roth IRA Rules and Contribution Limits for 2021

Joseph Meyer
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How Much Can You Contribute to a Roth IRA?

Where to Get Help Opening an Account

IRAs are retirement vehicles that allow you to invest money on a tax-deferred basis. The current suite of IRAs includes traditional IRAs, Roth IRAs, SIMPLE IRAs, SEP IRAs, and Rollover IRAs, which are all available in a variety of accounts, such as CDs, mutual funds, stocks, bonds, and exchange-traded funds.

In years past, there were several different account types for IRAs, including individual retirement accounts and custodial IRAs. However, the recent tax code overhaul has eliminated many account types and simplified the tax reporting rules for IRA accounts.

How Roth IRAs Work

A Roth IRA is a type of individual retirement account set up to help people save for retirement. One of the most attractive things about Roth IRAs is that the future tax implications of funding it are not immediately evident. There’s no specific tax deadline date since you are funding it with after-tax dollars, and you may not be taxed at all if you meet the eligibility criteria from this article.

Roth IRAs have been named after Senator William V. Roth Jr., who introduced the legislation creating Roth IRAs in 1997. Roth IRAs enable individuals to grow their retirement savings tax-free, provided they meet IRS-established criteria.

The Roth IRA has existed longer than Roth 401(k)s, which came into play in 2006. Very much like Roth IRAs, you fund Roth 401(k)s using after-tax dollars. The tax benefits of a Roth IRA are somewhat limited, but it is an option to consider, especially considering the current landscape on IRA contribution limits and eligibility.

Roth IRA Rules You Need to Know About

Who Qualifies?

The most important thing to remember with an IRA is that you can only contribute to it if you make paychecks … you can contribute if you’re self-employed, but you’re essentially contributing on a second income. The IRS rule was created to prevent retirees who no longer had to count on a steady income from being able to make contributions to an IRA.

The IRS rules also exclude the ability to contribute to an IRA if you’re underage. To contribute to an IRA, you will have to be an adult. This means that the years leading up to the year in which you turn 18 are the only time in which you cannot contribute to an IRA.

Under these rules, only people over the age of 18 can make contributions. People who are under the age of 18 cannot make IRA contributions. However, just because you shouldn’t be contributing to your IRA, that doesn’t mean you can’t open an IRA account … you can open one and use it for other investments, 401(k)s, or stocks … but you can’t put money into it for the purpose of making contributions.

Are You Required to Take Distributions?

Phase Outs and Income Limits

Contribution limits for Roth IRA accounts help the federal government off the backs of taxpayers. The government gives taxpayers a variety of tax deductions and credits but doesn’t give them enough money to pay for them. The government relies on taxpayers to make up the difference.

Taxpayers are willing to do that. Most will even give the government more.

For example, these days, you can get a tax break by contributing money to a Roth IRA. The government gives you an upfront break by allowing you to deduct the contributions, but you pay your share of the tax bill later.

The government limits the amount you can contribute to a Roth IRA each year. The IRS has a phase-out rule, which means you can’t contribute anything to your Roth IRA during years when your income is too high. The phase-out rule doesn’t apply to traditional IRAs, and that’s why we have the term “traditional versus Roth IRA.”

Here’s how the Roth IRA phase-out rule works:

If you’re married and file jointly, you lose your ability to contribute to a Roth IRA the first year in which your income is above “phase-out” level.

Conversions

When and Why You Might Consider Moving IRA Assets to a Roth IRA

A conversion is the transfer of assets from your traditional IRA to a Roth IRA. This is often done when someone is exposed to higher tax liabilities later in life and wants to minimize that possibility. But even in a lower tax bracket now, it may make sense to do a conversion. That’s because you don’t need to pay taxes on the assets that you convert. As they become more valuable in the future, you can just withdraw more money. Ultimately, it�s up to you to come up with the amount of money you want to be able to withdraw.

Conversions typically make sense if you are:

{1}. In a higher tax bracket now than you will be when you retire.
{2}. Want to postpone paying taxes on your retirement nest egg.
{3}. Want to have more control over when you have to pay taxes instead of just waiting for the income tax owed to be taken out of your retirement account.

Recharacterization

If you have already converted a traditional IRA to a Roth IRA, you have the ability to undo it by reversing the taxable amount you converted back to a traditional IRA.

In order to convert your traditional IRA to a Roth IRA in the first place, you have to pay federal income taxes on the amount that you roll over to the Roth IRA. If you choose to recharacterize the contribution, you must pretend that you never made that initial rollover in the first place. If you have already filed your return and paid taxes on the converted funds, you can file an amended return using Form 1040X by the original tax deadline.

If you will be recharacterizing the entire conversion, you do not have to wait until the tax deadline. However, you cannot recharacterize a tax-free amount like a Roth IRA conversion that is not taxable.

Be aware that if you ever recharacterize a contribution, you cannot convert it back to a Roth IRA. You are also limited to doing this once every 12 months. This means that you can recharacterize an old contribution, and make a new conversion within the same 12 months.

Penalties for Early Withdrawals

You can take money out of your Roth IRA at any time. However, you should be aware that there are penalties for withdrawals before you are 59.5. The only exception is if you use the money for a down payment on a home, to pay for college tuition, to purchase a first home or for qualified disability expenses.

Here are the rules for penalty-free distributions. If you take an early distribution from your IRA, you must pay taxes on that money. There is also a 10% penalty on top of that. So if you have a lot of money invested in IRAs, you better make sure you understand the rules before you take out money and run into trouble paying the penalties.

Summary

Roth IRA accounts were created to encourage people to learn about managing their money and to teach the basics of investing and retirement savings.

A Roth IRA Is Different from Other Types of Individual Retirement Accounts because the Roth IRA Does Not Grant the Tax-Deductible Contributions

Roth IRA distributions come out of income tax-free.

You must be at least 18 years old to open a Roth IRA, but the owner can be at least 70 ½ years old.

Roth IRA accounts are for the benefit of the individual who owns the Roth IRA, no matter who actually owns the account.