Roth IRA Rules and Contribution Limits 2021

Daniel Penzing
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Who Can Open a Roth IRA?

If you don’t know the answer to this question, you’re not alone. Although IRAs have been around since the Economic Recovery Tax Act of 1981, Roth IRA was the brainchild of the late U.S. Senator William V. Roth Jr. and was enacted in 1997. You don’t need any special qualification to open a Roth IRA except that you must have earned income. Whether you can contribute to the Roth IRA or not depends on how much you earned during the tax year and whether you meet certain other requirements.

As we discussed here, to contribute to a Roth IRA, you must have earned income. Long-term capital gains and qualified dividends may be considered earned income under certain circumstances. Here’s a list of all income sources that can be considered as earned income for Roth IRA purposes:

  • Wages, salaries, tips, and other taxable employee compensation;
  • Self-employment income;
  • Distributions from 401(k) plans, SEP plans, and IRAs (but not rollovers);
  • Income from partnerships, S corporations, and other flow-through entities;
  • Interest, ordinary dividends, annuities, rental income, and royalty income; and

Alimony and separate maintenance, including separate maintenance payments made pursuant to an order in a divorce decree or separation agreement.

Is a Roth IRA Right for Me?

The Roth IRA has been referred to as the best retirement plan for many reasons. In fact, it has many of the same benefits of the 401K or 403(b), but there are better advantages which make it even more attractive.

Tax Savings

One of the best things about a Roth IRA is that your earnings will not be subject to taxes when your money is in the account. You will get not future penalty tax or other tax on your earnings when you take them out in retirement.

You Must Be Age 70 ½ by the Time You Use the Money

There is a drawback if you have a Roth IRA. As the name of the IRA states, you will need to be age 70 ½ by the time you withdraw money from an account.

Unlike traditional IRAs and most other retirement accounts, you must begin taking your money out of a Roth IRA at the age of 70-1/2. If you are married and your spouse is the beneficiary of the Roth IRA, you have the option of taking it out at another time. You will need to do so temporarily because once your spouse passes away, it will need to be withdrawn by the end of the fifth year after your spouse has died.

What Are the Contribution Rules?

The contribution rules vary depending on whether you are working and the type of IRA you have.

The steps below follow the steps the IRS set forth for IRAs. However, some of the rules vary when you have a Roth IRA.

Single or Head of Household

Taxpayers who are not spouses filing jointly or are not qualifying widows or widowers with dependent children are limited in the amount they may contribute to their Roth IRAs.

These limits apply on a combination of adjusted gross income (AGI) and filing status that applies to you. You can determine these amounts by using the IRS Interactive Tax Assistant (ITA), which allows you to enter your tax and other information and get back Roth IRA contribution limits as well as other information about your tax situation.

Younger than 50: You may contribute up to the annual limit if you are under the age of 50 at the end of the tax year.

Married Filing Jointly or Qualifying Widow(er)

Married Filing Separately*

A married couple whose filing status is married filing separately may not contribute to a Roth IRA in the same year. If a married couple files separately, an IRA is not allowed for either spouse. Any contributions that an individual spouse makes to a Roth IRA are treated as after-tax contributions.

(Cite -1) IRS.GOV

If, however, you have a nonqualified spouse, significant other, ex-wife, or any other person that contributes to your household expenses and possibly under the official federal poverty guidelines you may be able to deduct your Roth IRA contribution.

What Are the Withdrawal Rules?

The Internal Revenue Code (I.R.C. – 26 and 408) and the equivalent IRS Publication 590 have specific regulations for the withdrawal of funds from your IRA account. Some IRA owners like to know how these laws apply to them and the funds in their retirement account, so let’s examine the rules and regulations.

Some of the general rules and regulations that apply to IRAs are:

You must begin taking distributions by April 1 in the year that you reach age 70½. The RMD must be made by December 31st. Any part of that distribution that is not taken as a distribution is subject to the 10% penalty tax. If you are married and your spouse is also the primary owner of the IRA, you can delay taking your first distribution if your spouse is “more than age 70½½. This allows you to roll your IRA into your spouse’s IRA account. This would also act as a “stretch IRA½ for your spouse and all IRA funds would remain untouched, for a longer period of time.

If you fail to take your required distribution by April of the year following the year you reach age 70½, the IRS will assess a schedule penalty tax of 50% of the distribution required.

Roth IRA FAQ

There are literally thousands of pages of rules on the IRS.gov website, and there are more than 8,000 pages in the Internal Revenue Code.

Since you have a limited amount of time to read them all, you need a trusted source to inform you of the Roth IRA rules of the road.

The following are answers to frequently asked questions. If you have additional questions, please feel free to contact my office.

What is a Roth IRA?

A Roth IRA is a special type of personal savings and retirement account. The income limitations to contribute to a Roth IRA are much more liberal than contributions to most other retirement plans.

An IRA is an individual retirement account. The Internal Revenue Service (IRS) originally established IRAs in 1975, and Congress has modified them many times since then.

How Do Taxes Play Into This?

One of the biggest differences between a Roth IRA and a traditional IRA is the tax treatment. With a traditional IRA, you can deduct your contributions from your income, meaning that the money in your IRA grows tax-free. When you withdraw money from a traditional IRA, the taxable amount is based on your contribution.

With a Roth IRA, you don’t get a tax deduction for your contributions, but your investment grows tax-free. Even more, there are no taxes on any qualified withdrawals. When you make withdrawals, qualified or not, you don’t have to pay taxes.

Can I Have Both a Roth and a Traditional IRA?

You can have both a Roth IRA and a traditional IRA, but you can have money in only one at a time. You can, however, roll your money from one into the other once a year. There is a limited time frame within which it needs to happen, though, so don’t procrastinate if you want to roll over a traditional IRA to a Roth IRA. You have until the tax-filing deadline to do it without penalty.

If you’re worried about how much extra tax you’d have to pay for pulling money out of a traditional IRA and putting it into a Roth IRA, don’t be. You can spread your rollover contributions over five years to make the difference less noticeable.

Open Your Roth IRA You Have up To

The contribution deadline for most retirement plans, including an IRA, is generally the due date of your tax return, including any extensions you file. For example, if your tax deadline is April 15, you generally have until then to make your contributions for the previous year.

Can I Have Both a Roth IRA and a 401(k)?

If you are not familiar with these retirement savings accounts, a traditional IRA is a tax-deferred account, while a Roth IRA is a post-tax account. At first glance, these two programs should not be in the same retirement budget. The traditional IRA was created to help taxpayers pay taxes on a yearly basis so they would not have to pay both at once. The Roth IRA was created for taxpayers who believed their tax rates would be lower in the future.

Can you have both a Roth IRA and a 401k at the same time? The answer is yes, but let’s dive into the details of each account.

What If My Income Is Too High for a Roth IRA?

A Roth IRA contribution occurs via a special account set up at a financial institution such as a bank or credit union. If you earn too much money, the IRS generally stops you from contributing to a Roth IRA for the year.

Fortunately, non-deductible IRA contributions and some other IRA contributions might still let you benefit from your retirement savings plan.

Is a Roth Right for Me?

This section covers the basics, but don’t stop here. Read the sections that follow to get a more complete picture of the Roth.

The Roth Individual Retirement Account was created to be a useful supplemental retirement vehicle for taxpayers who made too much to qualify for a traditional IRA. While similar to the traditional IRA, the Roth IRA has some notable differences. Contributions to a Roth IRA are not deductible and assets grow tax-free, like a traditional IRA. However, withdrawals from a Roth IRA are not subject to income tax, like withdrawals from a traditional IRA.

In essence, the issue for higher income taxpayers is the trade-off when converting their IRA assets into a Roth IRA:

Traditional IRA Income Tax: Pay tax now on deductible contributions and tax-deferred growth, or

Roth IRA Income Tax: Pay tax on current contributions only and tax-free growth, but upon withdrawal pay tax on all IRA assets.

Here are some general guidelines when deciding if you want a Roth IRA.

If you fall into the group of taxpayers who don’t qualify for the regular deduction of a traditional IRA – as income levels rise – then Roth IRA conversions will likely create tax savings. As your income increases, you will need to consider the trade-off of paying a tax today versus paying a tax on a future withdrawal – or even on nothing at all.