Among the many preparations needed for retirement and estate planning, retirement savings provide a fantastic tax shelter. However, you need to understand Roth IRA rules and other contribution requirements to maximize those tax savings.
Essentially, contributions to a retirement savings plan are made on a pretax basis – employers match employee contributions to a plan, but that “income” isn’t taxable until it’s received, once the employee has retired.
With a Roth IRA, the contributions you make aren’t tax-deductible, however, the withdrawals that you make in the future won’t be taxed – making it a great option for those who expect to have higher incomes in their retirement.
To learn more about Roth IRA and traditional IRA rules, read on for information that can help you amp up your savings and earnings.
The Roth IRA
The limit for Roth IRA contributions is $5000 if you’re under the age of 50 and $6000 if you’re over the age of 50. After 2008, those limitations are expected to increase in increments of $500, depending on the inflation rate.
Unfortunately, contributions are subject to eligibility limitations too. For example, a married couple that jointly earned between $150,000 and $160,000 or higher, or a single individual who earns $95,000 to $110,000 or higher can’t contribute to a Roth IRA. Instead, they must depend on a 401(k) Roth.
401 (k) Roth
Employees can now opt to make some of their elective retirement contributions Roth contributions. Historically, any deferred salary or 401(k) contributions were deducted from your taxable wages. However, any contributions considered Roth contributions to a 401(k) Roth are now included in a person’s taxable wages, though they may be free from federal income taxation.
Roth 401(k) plans are typically more advantageous for individuals with high incomes than a standard Roth IRA account. There are no AGI (amount of your income that’s taxable) limitations, and the contribution limit is significantly higher (currently sits just over $15,000 – and if you’re over 50, that increases to $20,000). The return on investment is also potentially significantly higher.
Switching from a Traditional to a Roth IRA
Unfortunately, you can only convert a traditional IRA to a Roth IRA if your Modified AGI income is less than $100,000 per year. Also, if you’re married, but file separately from your spouse then you are usually not allowed to convert your IRAs. However, your converted amount could be considered taxable income, though future growth is tax-free. Finally, when you convert to a Roth IRA, you aren’t required to make withdrawals at age 70.5.
If you’re concerned about the Adjusted Gross Income restrictions currently in place for Roth IRAs conversion, there is good news on the horizon. After 2019, new Roth IRAs rules will eliminate the $100,000 income limit on conversions from traditional IRAs to Roth IRAs. Also, any taxes due on 2019 conversions can be paid in a two-year installment.