All the Roth IRA Rules You Need To Know

Saving for retirement is one of the most important things you can do to prepare for the future. Roth IRAs are one popular tool for retirement savings due to their potential to provide tax-free income in your later years.

However, the rules surrounding Roth IRAs can be complicated, and knowing when to use one is difficult. We’ll break down everything you need to know.

Who Is Eligible for a Roth IRA?

A Roth IRA advantage is that it’s very easy to be eligible for one. Unlike 401(k)s, where you have to work for an employer that offers the account as a benefit, anyone can open a Roth IRA, as long as they have earned income for the year.

You can’t contribute to a Roth IRA if you do not have any earned income for the year or your income exceeds an upper limit. Some people have unearned income, which is income derived from things such as interest, dividends, capital gains, unemployment, Social Security, and pension benefits—these sources of income don't count as earned income.

Roth IRA Income Limits

There are income restrictions on who can contribute to a Roth IRA. While you need to have earned income to make contributions, your contribution limit can be affected by the amount of money you earn. As you earn more, your contribution limit decreases until you are no longer allowed to add money to the account.

The amount you earn in tax year 2022 before your contributions are limited depends on your tax filing status.

The incomes listed in the table above are based on your modified adjusted gross income (MAGI), which is your adjusted gross income plus deductions for educator expenses, alimony payments, and student loan interest.

Roth IRA Contribution Limits

Each year, there is a limit on the amount you can contribute to your Roth IRA. In tax year 2022, the limit is the lesser of $6,000 or your earned income. If you’re at least 50 years old, you can contribute an additional $1,000 each year, bringing your maximum contribution to $7,000. In tax year 2023, those numbers are $6.500 and $7,000, respectively.

If your MAGI is above certain thresholds, your ability to contribute is restricted. For example, a single person earning $129,000 or more can only contribute less than the $6,000 maximum. The more they earn, the less they can contribute, until their contribution limit reaches $0 if their MAGI reaches $144,000 or more in tax year 2022.

If your income exceeds the limit for a full contribution, you can determine the amount you can contribute using the following process:

1. Take your MAGI and subtract $204,000 if you’re married, $129,000 if you’re single.
2. Divide the result by $15,000 if single, $10,000 if you’re married.
3. Multiply the result by the maximum contribution for that year ($6,000 for tax year 2022).
4. Subtract that result from the maximum contribution for that year ($6,000 for tax year 2022).

So, if you are a single person and have a MAGI of $135,000, the math looks like this:

$135,000 - $129,000 = $6,000

$6,000 / $15,000 = 0.40

0.40 * $6,000 = $2,400

$6,000 - $2,400 = $3,600

You can contribute a maximum of $3,600.

Penalties for Excess Contributions

If you contribute more than you are permitted, generally speaking, you’ll have to deal with penalties. Excess IRA contributions are taxed at 6% per year for each year in which they remain in the IRA. To avoid this penalty, you have to withdraw the excess contributions and any of their earnings from the account.

There are some complex tax strategies, often called the “backdoor Roth,” that let you get around income limits and avoid these penalties. However, these can be difficult to implement.

Roth IRA Withdrawal Rules

The withdrawal rules for Roth IRAs differ slightly from the rules for traditional retirement accounts.

Like traditional retirement accounts, withdrawals are limited until you turn 59 ½. Once you reach that age, you can make withdrawals with no restrictions, as long as the account has been open for at least five years.

Before you turn 59 ½, you can withdraw contributions, but not earnings, from a Roth IRA tax-free and penalty-free. You can also withdraw money without paying a penalty if you are using it for:

• A first-time home purchase
• Qualified education expenses
• Qualified birth or adoption expenses
• You become disabled
• You use it for unreimbursed medical expenses or health insurance (if you’re unemployed)

You will pay taxes on these withdrawals unless the account has been open for five years or more.

If you make withdrawals for other reasons before you turn 59 ½, you have to pay taxes on any earnings you withdraw and will pay a 10% penalty on top of that.

Roth IRAs Have No RMD Rules

Some retirement accounts have required minimum distributions (RMDs) once you reach a certain age.

RMDs require you take a certain percentage of your account balance out of the account each year, which can affect your taxes, especially with traditional retirement accounts. Roth IRAs have no RMDs while the account holder is alive, so you can keep your money in the account, growing tax-free, for as long as you’d like.

Roth IRA Conversion Rules

If you have a traditional IRA, you can convert some or all of the money in it to a Roth IRA. Your brokerage should be able to help you complete this conversion.

Put simply, you tell your broker to convert the balance to a Roth IRA, then you pay income taxes on the amount converted because you didn’t pay that tax when putting it in a traditional IRA. This lets your money grow tax-free and helps you avoid RMDs.

One benefit of Roth IRA conversions is that there is no income limit on these conversions. If your income is too high to contribute to a Roth IRA, you can instead contribute to a traditional IRA and convert the balance to a Roth IRA.

The Bottom Line

Roth IRAs are a powerful tool for retirement saving. Unlike traditional retirement accounts, with a Roth IRA, you pay taxes on the money you contribute and receive tax-free withdrawals in retirement. This makes them a good choice for people in low tax brackets because their savings can grow tax-free.

Frequently Asked Questions (FAQs)