October 8, 2021
Roth IRAs offer several tax benefits, retirement savings opportunities, and liquidity benefits. Below are the most notable advantages the Roth IRA offers over other retirement accounts.
Tax-free savings growth and other contribution rules
Unlike a traditional IRA, a taxpayer cannot deduct contributions to a Roth IRA. However, taxpayer can make contributions when they are participants in other retirement plans and even after they are reaching age 70 ½. The allowable contribution amount for a Roth IRA is limited based on taxpayer’s filing status and modified adjusted gross income (MAGI). For example, in 2021, the adjusted applicable amount for a taxpayer filing a joint return is $198,000 and $125,000 for any other taxpayers. In addition, for 2020 and 2021, total contributions to all a taxpayer's traditional and Roth IRAs cannot be more than the lesser of $6,000 ($7,000 if they are age 50 or older), or their taxable compensation for the year.
Withdrawal rules and tax-free distributions
Because Roth IRA contributions are made with after-tax dollar, withdrawals of Roth IRA contributions are always both tax-free and penalty-free. For earnings distribution, it depends on whether the distribution is qualified. Qualified distributions from Roth IRAs are tax free, but nonqualified distributions may be subject to tax and a 10% early withdrawal penalty. A qualified distribution must meet one of the following tests:
It is made on or after the day on which the taxpayer turns age 59 ½.
It is made to a beneficiary (or to the taxpayer's estate) on or after the taxpayer's death.
It is attributable to the taxpayer's being disabled.
It is used for a qualified first-time home purchase.
Even if one of the above four requirements are met, a distribution from a Roth IRA is not treated as a qualified distribution if the distribution is made within the five-taxable year period. Thus, both the five-year holding period and satisfying one of the above four requirements must be met for the distribution to be a qualified distribution.
No required minimum distributions (RMDs)
Generally, required minimum distributions (RMDs) must be taken from a traditional IRA, SEP IRA, and SIMPLE IRA by the required beginning date. Annual RMDs must continue to be taken after the required beginning date. The failure to take the proper RMD subjects the taxpayer to a 50% excess accumulation penalty. For a Roth IRA owner, it is not required to take RMDs during their lifetime. However, once the owner dies, the post-death RMD rules that apply to traditional IRAs also apply to Roth IRAs.
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