Choosing a Roth IRA

Leslie Beck |

There are many vehicles to choose from as you travel the road to retirement. One of the more advantageous means to build a nest egg is the Roth IRA.

A Roth IRA is an Individual Retirement Account that allows you to contribute after-tax dollars into a savings or brokerage account. The after-tax dollars won’t allow you to claim a tax deduction as you might on a traditional IRA, but withdrawals are not subject to federal income taxes when withdrawn after 59 ½ years of age, as long as the account has been opened for at least five years.

Like a traditional IRA, interest, dividends, and capital gains are sheltered from taxes while inside the Roth.

Tax time

Subject to income limits, in 2020 you may contribute up to $6,000 per year if you are under 50 and $7,000 per year if you are 50 or over.

For someone who is single (or head of household), you are eligible to make the full contribution to a Roth if your modified adjusted gross income (MAGI) is under $124,000 for the tax year 2020. The limit gradually declines as income increases between $124,000-$139,000.  Above $139,000, Roth contributions are not allowed.

If you are married and filing separately, the rules become a little more complex, so we won’t cover them here.

If you are married and file jointly (or qualified widow/er), MAGI must be under $196,000 for the tax year 2020, while the contribution limit is gradually phased out as income rises between $196,000-$206,000. Above $206,000, Roth contributions are not allowed.

You may contribute to a Roth and a traditional IRA, but you may not exceed the total prescribed annual limits.

Another great feature of Roth IRAs in addition to tax-free withdrawals, Roth IRAs are not subjected to required minimum distributions.

However, under the SECURE Act, an inherited Roth IRA (and a traditional IRA) must be distributed within 10 years if the beneficiary is not your spouse (in most cases).

But unlike a traditional inherited IRA, the distributions from an inherited Roth IRA are tax free. And beneficiaries may let the Roth account grow tax free until year 10, when the distribution is required.


High-income taxpayers and the backdoor Roth

If you have a healthy six-figure income, hard limits prevent you from contributing directly to a Roth. But income limits don’t exist for converting a traditional IRA into a Roth, which leaves a loophole for high-income taxpayers. Conceptually, the backdoor Roth strategy is relatively straight-forward if you have no other IRAs. You make a non-deductible contribution to a traditional IRA, open up a Roth IRA, convert your traditional IRA contribution to the Roth IRA, and pay taxes on any appreciation.  If there are other IRAs in your name, taxes are pro-rated.

Finally, many 401(k) plans offer a Roth IRA feature, which allows anyone to contribute to a Roth that way (although employer matches will go into the tax-deferred portion of the 401(k)).

Before considering a Roth IRA or a backdoor Roth, you may want to consult with your tax advisor.