Taxes and Finance: The tax-free retirement savings option

Is a Roth IRA right for you?

Tip Category: Retirement

If you are looking for tax-free income and more flexibility during retirement, perhaps you should look into investing in a Roth IRA. While Roth IRA contributions are not sheltered from current taxes like contributions to traditional IRAs, they offer other tax benefits during retirement.

The Roth IRA advantage

Retirement withdrawals (including earnings) are tax-free. As long as you wait to take distributions until you are 59 ½ or older, the full amount of your Roth account is tax-free!

Save taxes on other earnings. During retirement, withdrawals from traditional IRAs increase your taxable income. This can bump other earnings into a higher tax bracket and potentially increase the taxability of your Social Security benefits. Conversely, Roth withdrawals are not reported as income, keeping tax rates as low as possible.

More flexibility during retirement. In 2023 and later, once you turn 73 the IRS requires that you take required minimum distributions (RMDs) from traditional IRAs. If you don’t, you’ll get hit with a 50 percent penalty! There is no such requirement for Roth IRAs. You can leave (and even contribute) funds to grow in the account as long as you want.

Contributions can be withdrawn tax-free at any age. If you have a financial hardship and need to make an early withdrawal, only the earnings in a Roth are subject to a 10 percent early withdrawal penalty. Meaning, Roth contributions can be withdrawn tax-free and penalty-free at any time. This is because you use after-tax funds to make your original Roth contributions. This is not the case with traditional IRAs — the full withdrawal is subject to the penalty if you make it before you turn 59½.

The Roth IRA is not for everyone

While there are many reasons to consider contributing to a Roth IRA, they are not for everyone. Here are some factors to consider:

Income limits. While there are no income limits if you wish to roll funds from other accounts into a Roth IRA, there are income limits to contribute to a Roth IRA. For 2022 they are $144,000 single ($153,000 in 2023) and $214,000 married ($228,000 in 2023).

Contribution limits. In 2022, you can contribute a maximum of $6,000 ($7,000 if age 50 or over). This amount increases by $500 in 2023.

Five-year active account requirement. To receive the full tax-free benefit of Roth investment earnings, you must have your Roth account for five years before making withdrawals.

Future tax uncertainty. While no one knows what the future holds, keeping tabs on tax trends is an important aspect of retirement planning. Increasing or decreasing tax rates may ultimately determine the best type of retirement investment for you. In addition, the government has the power to change the taxability of your IRA if they deem it necessary.

If you are looking to maximize your savings for 2022, you still have until April 18, 2023 to contribute into an IRA.

James Angell is a Willits based Certified Public Accountant. His office is located at 461 S. Main St. and he can be reached at 707-459-4205.