Table of Contents
- What's good about investing in IRAs?
- Can anyone have a traditional IRA?
- Can my stay at home spouse have an IRA?
- What makes Roth IRAs so special?
- Can anyone have a Roth IRA?
- Can I set up a Roth IRA for my spouse?
- Can I set up a Roth IRA for my child?
- What's the downside to Roth IRAs?
- What can I do if I converted to a Roth IRA and my income exceeds $100,000?
- What if my Roth IRA assets fall in value after conversion?
- How are my heirs taxed on inherited Roth IRA wealth?
There are two types of IRAs, Traditional IRAs and Roth IRAs, both of which are discussed in this Financial Guide. Traditional IRAs defer taxation of investment income and withdrawals are taxable income--except for withdrawals of previously non-deductible contributions. In most cases, however, contributions are deductible. Roth IRAs are subject to many of the same rules as Traditional IRAs, but there are several differences, the primary one being that contributions are not deductible and are made after-tax. As such, qualified distributions are generally tax-free.
If you have income from wages or self-employment income, you can contribute up to $6,000 in 2021 (same as 2020). As such, IRAs are available even to children who meet these conditions. Persons age 50 and older can contribute an additional $1,000 for a total of $7,000 in 2021 (same as 2020).
Yes. Contributions of $6,000 for each spouse are allowed in 2021 (same as 2020) if the couple's wages or self-employment earnings are $12,000 or more.
Roth IRAs offer the following advantages:
- Withdrawals, if they qualify, are completely exempt from income tax, unlike all other retirement plans.
- You can quickly build up a Roth IRA account by converting traditional IRAs into Roth IRAs, but there is a tax cost.
- Since there is no age requirement for withdrawals from a Roth IRA, more money can be left in an account and passed on to heirs than is allowed under other plans.
Not everyone can have a Roth IRA. The following conditions apply:
- You can't contribute to a Roth IRA for a year with income (AGI) above $140,000 if single or $208,000 on a joint return in 2021 ($139,000 and $206,000, respectively, in 2020).
- You must have earnings from personal services (at least $6,000 or more) to make the (maximum) contribution, although an additional contribution of $1,000 is allowed for persons age 50 and over.
Yes, subject to the income conditions above. This allows contributions of $6,000 each if the couple's earnings are at least $12,000 in 2021($13,000 if only one of you is age 50 or older or $14,000 if both of you are age 50 or older). Each spouse can make a contribution up to the current limit; however, the total of your combined contributions can't be more than the taxable compensation reported on your joint return.
Yes, for a child with personal service earnings, and subject to the other income conditions.
The following is a brief list of negative issues regarding Roth IRAs:
- Roth IRA contributions are not tax-deductible. There's never a deduction for Roth IRA contributions.
- To build a sizable Roth IRA fund, you must convert a traditional IRA (or, after 2007, funds from an employer plan). Conversions are taxable.
Under the new tax reform law, for taxable years beginning after December 31, 2017, if a contribution to a regular IRA has been converted into a contribution to a Roth IRA, it can no longer be converted back into a contribution to a regular IRA. This provision prevents a taxpayer from using recharacterization to unwind a Roth conversion.
The income limit was permanently removed for tax years starting in 2010. Anyone, even those with high incomes, can convert from a traditional IRA to a Roth IRA.
When you convert from a traditional IRA to a Roth IRA you pay taxes on the value of your account as of the conversion date. If your account loses value and the account is worth less money you'll end up paying taxes on the money you no longer have in your account.
Say you convert $50,000 in a traditional IRA to a Roth IRA and the value drops to $35,000. If you didn't make any nondeductible contributions, the taxable distribution would be $50,000 and that would be the amount you would be paying taxes on. However, now your account is only worth $35,000. By re-characterizing the account you can avoid paying taxes on the money you no longer have ($50,000). You'll be back to a traditional IRA, but of course, the account is now worth only $35,000.
Prior to 2018, the IRS allowed you "re-characterize" the account back to a traditional IRA, essentially putting you right back where you were - at least tax-wise. However, tax reform legislation passed in 2017 repealed this special rule, and re-characterizations are no longer permitted.
Your heirs are taxed as follows:
- No tax paid on withdrawals as long as the funds have been in the Roth IRA for at least five years.
- Starting in 2020 (SECURE Act), an heir inheriting a Roth IRA must withdraw the funds within 10-years after the account owner's death (some exceptions apply). Heirs with Roth IRAs inherited prior to 2020 can spread the withdrawal over his or her life, continuing the tax shelter for amounts not withdrawn.
- Estate tax treatment is the same as for traditional IRAs.