18 Aug What You Need to Know About the Roth IRA in 2021
Created by congress more than 20 years ago, the Roth Individual Retirement Account (or Roth IRA) is a type of retirement savings account. An article in ProPublica recently revealed that PayPal founder Peter Thiel’s Roth IRA has grown from $2,000 to $5 billion over 20 years. Though astronomical growth like this is usually only possible if you have access to the kinds of stock deals available to Theil and other wealthy investors like him, the average American can still benefit from using a Roth IRA for stashing and growing retirement savings. In fact, in the first quarter of 2020, the average IRA balance (including traditional and Roth IRAs) was $98,900.
Tax Benefits of the Roth IRA
Unlike traditional IRAs and 401(k)s that allow you to use pre-tax dollars when making contributions, Roth IRA contributions are made with after-tax dollars. However, this trade off comes with substantial benefits: money in your Roth IRA will grow tax-free and can be withdrawn tax-free during retirement. And because there are no minimum distributions required, the funds you stash in a Roth IRA can enjoy this tax-free growth even longer.
In order to withdraw your Roth IRA savings tax-free, you must fulfill the Roth IRA five-year rule. This rule basically stipulates that you must leave your contributions and earnings in your Roth IRA for at least five years from the beginning of the tax year in which you made your first contribution. This applies no matter how old you are when you open a Roth IRA.
Income and Contribution Limits
If you are a single tax filer, your Modified Adjusted Gross Income (or MAGI) must be under $140,000 for tax year 2021 in order to contribute to a Roth IRA. For married people who file jointly, your MAGI must be under $208,000 for tax year 2021. If you’re married but file separately, your ability to contribute to a Roth IRA is further limited. If you lived with your spouse at any time during the year, your MAGI must be lower than $10,000 to contribute to a Roth IRA. However, if you are physically separated and have not lived with your spouse at all during the year, you can contribute to a Roth IRA as long as your MAGI is less than $125,000.
The amount you can contribute to your Roth IRA each year is also limited by your income. The IRS has a comprehensive chart you can refer to here. The maximum contribution is $6,000 for individuals under age 50 and $7,000 for those age 50 or over. The maximum is reduced as income increases, so the closer you get to the income limit, the less you can contribute to your Roth IRA each year.
The Spousal Roth IRA
If you’re married and only one spouse earns taxable income, you can open a spousal Roth IRA and effectively increase the amount you’re able to stash away each year. A spousal Roth IRA allows the income earner to contribute on behalf of a spouse who doesn’t work for pay. Depending on your income, your total contributions to both Roth IRAs can be a maximum of $12,000 if you’re both under age 50, or $14,000 if you’re both age 50 or older. You must be married and file taxes jointly to take advantage of a spousal Roth IRA. You can’t make contributions to your spouse’s Roth IRA if you file separately.
Have questions? We have answers. Reach out today for a free consultation to see if a Roth IRA is optimal for your financial situation.