What is a Roth IRA?
A Roth IRA is an Individual Retirement Arrangement. It is a personal Investment Account used to save for retirement. This is why it is commonly called an Individual Retirement Account.
Differently than other qualified retirement accounts (Traditional IRA, 401(k), 403(b), SEP IRA, SIMPLE IRA, Etc.), contributions made to a Roth IRA are post-tax, also called after-tax (taxes have already been paid on the dollars).
Similar to other qualified retirement accounts contribution values inside the account grow tax-deferred until distributed.
Best of all, conversely to most other qualified retirement accounts, Qualified Roth IRA distributions are completely tax-free.
Why was the Roth IRA conceived?
Ronald Reagan & TRA 1986
The Tax Reform Act of 1986, signed by Ronald Reagan, was a monumental piece of legislation and altered many aspects of the Federal Tax Code. One of the smaller but consequential changes was the elimination of the deductibility for Traditional IRA contributions for low-income earners.
This small change had two consequential impacts.
IRA savings fall off a cliff
Between 1986 and 1987 IRA contributions fell by 62%. Research began to suggest it was a direct result of TRA 1986. Taxpayers seemed to genuinely value the up-front tax deduction provided by traditional IRAs.
Senators William Victor “Bill” Roth Jr. & Bob Packwood enter the room!
A passionate advocate for personal retirement accounts Senator William Victor “Bill” Roth Jr. was not a fan of TRA 1986 and the effect it had on IRA savings. Mr. Roth got to work on ideas to restore the value of IRAs to taxpayers.
At the same time Senator Bob Packwood, a key architect of TRA 1986, was doing his part to uphold the promise of capital gains tax cuts he viewed got President Bush elected. The revenue lost from lower capital gains tax rates needed to be offset by eliminating the upfront tax deductions from Traditional IRA contributions.
The result was a 1989 collaboration originally called “IRA Plus”.
The Roth IRA was born
“IRA Plus” was codified into law by the Taxpayer Relief Act of 1997 (Public Law 105-34) as the Roth IRA, named after our favorite Senator, Bill Roth.
Distinct from its retirement account predecessors, Roth IRAs allowed for earnings to be withdrawn in retirement without an income tax. A first.
What is a Roth IRA NOT?
#1 – A Roth IRA is NOT a joint account. INDIVIDUAL retirement arrangement.
#2 – Just like a Shoebox is NOT shoes. A Roth IRA is NOT an investment.
The Roth IRA is the account where investments are made.
Who is eligible to contribute to a Roth IRA?
Anyone (even babies 👶) who have received taxable compensation (commonly called earned income) for the year can make a Roth IRA contribution, with 2 notable exceptions:
- High-Income Earners are “phased out” of making contributions directly to a Roth IRA (see table below). They must make contributions through the “backdoor”.
- If you earn less than the Roth IRA contribution maximum(s) you can only contribute up to the amount you earn.
- For Example, 👶Roro earns $1,500 for model services for her dad’s media company. 👶 Roro can contribute no more than $1,500 to her Roth IRA.
👉 Pro-Tip: For married couples, who file a joint tax return, taxable compensation makes each spouse eligible via Spousal Contributions.
- If the married couple is 50+ and one spouse has taxable compensation of at least $14,000 – both spouses can fund their Roth IRA with $7,000
- If the married couple is 0-49 yrs old and one spouse has taxable compensation of at least $12,000 – both spouses can fund their Roth IRA with $6,000
- If taxable compensation is $8,000, then only $8,000 can be invested between the two spouses’ Roth IRA due to the maximum contribution amounts.
❗Be mindful of what taxable compensation (earned income) includes (see below)!
| Includes: | wages, salaries, etc. | commissions | self-employment income | taxable alimony and separate maintenance | nontaxable combat pay | taxable non-tuition fellowship and stipend payments |
| Excludes: | earnings and profits from property | interest and dividend income | pension or annuity income | deferred compensation | income from certain partnerships | any amounts you exclude from income |
How much can I fund my Roth IRA with?
| Maximum direct Contribution for individuals 0-49 yrs old | Maximum direct Contribution for individuals age 50+ | Single Filers Income (MAGI) | Married Filing Jointly Income (MAGI) | Married Filing Separately Income (MAGI) |
| $6,000 | $7,000 | under $129,000 | under $204,000 | $0 |
| $5,400 | $6,300 | $130,500 | $205,000 | $1,000 |
| $4,800 | $5,600 | $132,000 | $206,000 | $2,000 |
| $4,200 | $4,900 | $133,500 | $207,000 | $3,000 |
| $3,600 | $4,200 | $135,000 | $208,000 | $4,000 |
| $3,000 | $3,500 | $136,500 | $209,000 | $5,000 |
| $2,400 | $2,800 | $138,000 | $210,000 | $6,000 |
| $1,800 | $2,100 | $139,500 | $211,000 | $7,000 |
| $1,200 | $1,400 | $141,000 | $212,000 | $8,000 |
| $600 | $700 | $142,500 | $213,000 | $9,000 |
| Only indirectly through the “backdoor” | Only indirectly through the “backdoor” | $144,000 & over | $214,000 & over | $10,000 & over |
How do I get my own Roth IRA?
A Roth IRA must be established with a financial institution that has received IRS approval to offer IRAs. This includes most Financial Institutions that custody customer assets. These include banks, brokerage companies, federally insured credit unions, and savings and loan associations.
The most common location for a Roth IRA to be invested are brokerage companies like Fidelity, Charles Schwab, TD Ameritrade, Etc.
A Roth IRA can be opened at any time. Once you have established a $0 balance receiving Roth IRA at a qualifying financial institution you can contribute funds.
What can fund my Roth IRA?
- Regular contributions
- Spousal IRA contributions
- Transfers
- Rollover contributions
- Conversions
What can’t fund my Roth IRA?
You can never fund a Roth IRA with securities or property.
When do I fund my Roth IRA?
A Roth IRA can be funded at any time as well, but as with most things in life, timing matters.
If you make a Roth IRA contribution before December 31st of the current calendar year, that contribution can only count toward the current calendar year.
If you make a Roth IRA contribution before the current calendar year tax filing deadline (typically April 15th of the following year)and after December 31st of the current calendar year, you can CHOOSE to count the contribution toward the current calendar year or the following calendar year.
If you make a Roth IRA contribution after the prior calendar year’s tax filing deadline (typically April 15th) you must count this toward the current calendar year.
❗Tax filing extensions do not extend your IRA contribution deadlines. ❗