Financial Freedom: Let me break it down (Video)

Let's talk about retirement accounts. If you have wages, you are likely eligible for this very valuable retirement investment vehicle. The IRS deadline for contributing to your Roth Ira is quickly approaching. Here is some important information on the Roth Ira, a key tool for retiring (early).


What Is a Roth IRA?

A Roth IRA is an individual retirement account (IRA) that allows qualified withdrawals on a tax-free basis provided certain conditions are satisfied. Roth IRAs are similar to traditional IRAs, with the biggest distinction between the two being how they’re taxed. Roth IRAs are funded with after-tax dollars; the contributions are not tax-deductible. But once you start withdrawing funds, the money is tax-free. Conversely, traditional IRA deposits are generally made with pretax dollars; you usually get a tax deduction on your contribution and pay income tax when you withdraw the money from the account during retirement.


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Contribute to your prior year's Roth IRA before tax day of the current year - typically April 15. Talk to your tax accountant for detailed information.


When can I access Roth IRA funds:

At any time, you may withdraw contributions from your Roth IRA, both tax- and penalty-free. If you take out only an amount equal to the sum you've put in, the distribution is not considered taxable income and is not subject to penalty, regardless of your age or how long it has been in the account. In IRS-speak, this is known as a qualified distribution.


However, there's a catch when it comes to withdrawing account earnings—any returns the account has generated. For distribution of account earnings to be qualified, it must occur at least five years after the Roth IRA owner established and funded his/her first Roth IRA, and the distribution must occur under at least one of the following conditions:


  • The Roth IRA holder is at least age 59½ when the distribution occurs.

  • The distributed assets are used toward the purchase—or to build or rebuild—a first home for the Roth IRA holder or a qualified family member (the IRA owner's spouse, a child of the IRA owner and/or of the IRA owner's spouse, a grandchild of the IRA owner and/or of their spouse, a parent or other ancestor of the IRA owner and/or of their spouse). This is limited to $10,000 per lifetime.

  • The distribution occurs after the Roth IRA holder becomes disabled.

  • The assets are distributed to the beneficiary of the Roth IRA holder after the Roth IRA holder's death.


The 5-Year Rule

Withdrawal of earnings may be subject to taxes and/or a 10% penalty, depending on your age and whether you've met the 5-year rule. Here's a quick rundown.


If you meet the 5-year rule:

  • Under 59½: Earnings are subject to taxes and penalties. You may be able to avoid taxes and penalties if you use the money for a first-time home purchase (a $10,000-lifetime limit applies), if you have a permanent disability, or if you pass away (and your beneficiary takes the distribution).

  • Age 59½ and older: No taxes or penalties.


If you don’t meet the 5-year rule:

  • Under 59½: Earnings are subject to taxes and penalties. You may be able to avoid the penalty (but not the taxes) if you use the money for a first-time home purchase (a $10,000-lifetime limit applies), qualified education expenses, unreimbursed medical expenses, if you have a permanent disability, or if you pass away (and your beneficiary takes the distribution).

  • 59½ and older: Earnings are subject to taxes but not penalties.


This information was provided from Investopia. We encourage you to talk to your accountant about your specific situation before investing.



How a Roth IRA works

A Roth IRA is an individual retirement account in which money grows tax-free and withdrawals in retirement are tax-free. Here are the five key characteristics of a Roth IRA.

  1. You pay taxes on money you put in the account. You cannot deduct the contributions on your taxes.

  2. In 2020 and 2021 you can contribute up to $6,000 ($7,000 if you're 50 or older).

  3. You cannot contribute to a Roth IRA if your modified adjusted gross income (MAGI) was more than $139,000 in 2020 (single filers) or $206,000 (married filing jointly). In 2021 the MAGI limit is $140,000 (single filers) or $208,000 (married filing jointly). (The backdoor Roth strategy offers a workaround to these limits.)

  4. People at least 59½ years old and who hold their accounts for at least five years can take distributions, including earnings, without paying federal taxes.

  5. You don't have to take any money out of your Roth IRA if you don't want to. There are no required minimum distributions (RMDs).


Who can open a Roth IRA?

To open a Roth IRA, you must have earned income and your income cannot exceed certain limits. Here are the basic rules and qualifications.


You must be under the income limit. To contribute to a Roth IRA, your modified adjusted gross income (MAGI) must be under $139,000 in 2020 (single filers) or $206,000 (married filing jointly). In 2021 the MAGI limit is $140,000 (single filers) or $208,000 (married filing jointly). (IRS Publication 590-A, Worksheet 2-1 has complete instructions on figuring MAGI for Roth IRAs.)


You have to have earned income. You must have income from work (the IRS term is "taxable compensation"). The max you can contribute to a Roth in a year is your income from work or $6,000 ($7,000 if you're age 50 or older), whichever is less.


Learn all of the details on the IRS website and at NerdWallet. Then, talk with your tax accountant!


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