Roth IRAs are really popular because they give you tax-free withdrawals in retirement, but they also have some of the trickiest rules of any major retirement account.
If you hope to get the greatest value out of yours while avoiding costly penalties, you need to know the following three things about your Roth IRA.
1. Income limits
Not everyone can contribute to a Roth IRA. Most workers can set aside up to $7,000 to one of these accounts in 2024 if they're under 50 or $8,000 if they're 50 or older. But some high earners have a lower contribution cap, and some can't contribute directly to a Roth IRA at all.
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This table illustrates how much a person can contribute to a Roth IRA in 2024 based on their tax filing status and modified adjusted gross income (MAGI):
|
Tax Filing Status |
Contributions Up to the Limit |
Reduced Contribution Limit |
No Roth IRA Contributions |
|---|---|---|---|
|
Single, Head of Household, or Married Filing Separately If Living Apart From Spouse All Year |
MAGI under $146,000 |
MAGI between $146,000 and $161,000 |
MAGI over $161,000 |
|
Married Filing Jointly |
MAGI under $230,000 |
MAGI between $230,000 and $240,000 |
MAGI over $240,000 |
|
Married Filing Separately If Living With Spouse At Any Point During the Year |
N/A |
MAGI under $10,000 |
MAGI over $10,000 |
Data source: IRS. Table by author.
You don't want to contribute more than you're allowed to, or you could pay a 6% excess contribution penalty for every year you fail to correct the error.
If you don't believe you can contribute to a Roth IRA directly but still want Roth funds for retirement, you could always try a backdoor Roth IRA. This is where you make traditional IRA contributions and then do a Roth IRA conversion in the same year. It's a few extra steps, but it'll help you reach the same end result.
2. How the IRS taxes Roth IRA funds
The IRS taxes your Roth IRA contributions in the year you make them, unlike contributions to traditional IRAs or most 401(k)s. But since you pay these taxes upfront, you can withdraw your contributions tax-free at any age. There's no 10% early withdrawal penalty, either. This makes Roth IRAs a popular choice for those who plan to retire before 59 1/2 (when they gain penalty-free access to their 401(k) and traditional IRA funds).
But for earnings, the withdrawal rules are a little more complicated. You will pay a 10% early withdrawal penalty if you take earnings out of your Roth IRA while under 59 1/2 unless you have a qualifying reason. This includes things like paying for a first-home purchase ($10,000 maximum withdrawal) or becoming disabled.
3. The five-year rule
The five-year rule also affects how the IRS taxes Roth IRA earnings. Essentially, it states that you must have a Roth IRA for at least five years before you can withdraw your earnings tax-free. Taking earnings out sooner will trigger income taxes. This is true even if you're over 59 1/2 at the time, though in this situation, you wouldn't have to worry about an early withdrawal penalty.
There's also a separate five-year rule for Roth IRA conversions. If you convert money from a 401(k) or traditional IRA to a Roth IRA, that money must remain in the account for five years before you can withdraw it tax-free.
However, the five-year clock begins on Jan. 1 of the year you do the conversion. So any Roth IRA conversions done in 2024 will be eligible for tax-free withdrawal on Jan. 1, 2029. But again, you have to wait until you're at least 59 1/2 if you hope to avoid the early withdrawal penalties.
It's also worth noting that even if you can withdraw your Roth IRA funds well before retirement, it's not always the right move. Doing so will halt the growth of your savings, and you may have to set aside even more per month going forward to retire when you originally planned. So think through your decision carefully, and review the tax implications of your choice before you go ahead with it.
