Unlike many employer-sponsored retirement plans in which access to assets might be limited until the participant has a change of employment or reaches retirement age, access to IRA assets is guaranteed, always. Most Traditional IRA distributions taken before the IRA owner reaches age 59½ are subject to a 10 percent early distribution penalty tax. This is to discourage people from taking Traditional IRA distributions at an early age rather than keeping the assets for retirement. The 10 percent early distribution penalty tax does not apply in the following situations.
- Age 59½
- Certain medical expenses
- Health insurance premiums following unemployment
- First home buyer expenses
- Higher education expenses
- IRS levy
- Series of substantially equal periodic payments
- Qualified reservist distributions
IRS Publication 590, Individual Retirement Arrangements (IRAs), provides more detail on these penalty tax exceptions.
Traditional IRA distributions become mandatory beginning in the year that a Traditional IRA owner turns age 72. These mandatory distributions are called required minimum distributions (RMDs). IRA owners must begin taking RMDs by April 1 of the year following the year they turn 72. These distributions are based on the IRA balance divided by the applicable distribution period. Because IRAs were created to provide income during retirement—not to be a tax shelter— IRA owners failing to take their RMDs are subject to a 50 percent excess accumulation penalty tax on the assets that should have been distributed but were not.
Ensuring financial security in retirement is one of the greatest challenges facing American workers today. Concern regarding the long term viability of Social Security continues to grow, and Americans are looking for new ways to secure their financial future. The following trends show the importance of saving for retirement.
- Individuals are changing jobs more frequently, which might reduce their chance of acquiring great reserves in company pension plans.
- Many new entrepreneurs striking out on their own cannot offer retirement options for themselves or to their employees until the company is more financially secure.
- Social Security is no longer seen as the answer to retirement funding.
Individuals need to take responsibility to build their retirement nest egg. The Roth IRA allows individuals to invest after-tax dollars today, and let the assets grow with the potential to distribute the principal and earnings tax- and penalty-free during retirement.
Imagine for a moment that an individual has just received a check. She looks at her summary and notices that federal income taxes were not withheld. Her initial reaction is that something is wrong—it's not—if this check is from her Roth IRA.
Two factors make this possible.
- First, the money an individual contributes to a Roth IRA has already been taxed (individuals cannot take a tax deduction for their Roth IRA contributions). So the principal amount is never subject to future taxes or penalties as long as individuals stay within the contribution guidelines.
- Second, the Roth IRA allows contributions to grow tax-deferred. If an individual does not distribute any of the earnings until he has had the Roth IRA for at least five years and has a qualifying event (generally turning age 59½), those tax-deferred earnings are tax-free.
There is no age limit on making contributions. But individuals must have eligible compensation, which is defined the same as for Traditional IRAs. As long as an individual satisfies the Roth IRA requirements, she/he may contribute to a Roth IRA.
The annual regular contribution limit is the lesser of $6,000 (plus catch-up contributions, if eligible) or 100 percent of eligible compensation (generally earned income). IRA owners age 50 or older by the end of the tax year may increase their IRA contributions to help "catch-up" on their retirement savings, for a maximum contribution of $7,000. The contribution limit applies to all Traditional and Roth IRA contributions made for the year, in aggregate.
Roth IRA contribution eligibility depends on the individual’s (or if married, the individual and the spouse’s) modified adjusted gross income (MAGI) and income tax filing status. The amount that an individual is eligible to contribute is reduced if his MAGI falls within or below certain phase-out ranges.
The 2021 MAGI phase-out ranges are listed below.
|Filing Status||2021 MAGI|
|Single Filer and Head of Household||$125,000-$140,000|
|Married, Filling Joint||$198,000-$208,000|
|Married, Filing Separate||$0-$10,000|
The following specific details for Roth IRA contributions are based on 2021 figures.
- Single individuals with MAGI of $125,000-$140,000 may contribute the maximum annual contribution ($6,000, plus catch-up contributions up to $1,000 if eligible) to their Roth IRAs.
- Married individuals who file joint income tax returns with joint MAGI of $198,000-$208,000 may contribute the maximum annual contribution to their Roth IRAs.
- Married individuals who file separate returns with MAGI of less than $10,000 may make partial contributions to their Roth IRAs.
Yes. An individual may convert assets from a Traditional IRA to a Roth IRA. The individual must pay tax on any previously untaxed dollars converted from, but the 10 percent early distribution penalty tax does not apply to the conversion amount. Individuals should seek advice from a competent tax advisor to determine whether converting pretax retirement assets is beneficial.
For more information on conversions, see "Conversion From a Traditional IRA" under the Help section in the IRA Section Center.
There are no required minimum distributions due upon attaining age 72. Earnings can continue to grow tax-deferred until the Roth IRA owner takes a distribution. There are special distribution requirements, however, after the IRA owner dies.
Individuals may take a qualified Roth IRA distribution tax- and penalty-free. A distribution of Roth IRA assets is considered a qualified distribution if two requirements are met. First, the Roth IRA must satisfy a five-year waiting period, beginning with the first day of the year for which the Roth IRA owner makes a regular contribution or, if earlier, in which the Roth IRA owner completes a conversion or retirement plan rollover. Second, the distribution must be made because of one of the following events.
- Age 59½
- First-time homebuyer
Distributions that meet the above requirements are referred to as "qualified distributions." While individuals may take distributions from their Roth IRAs at any time, distributions that are not qualified distributions may be subject to taxes (and in some cases the 10 percent early distribution penalty tax).
Eligible taxpayers may deposit up to $2,000 per year into an ESA for a child under the age of 18. Parents, grandparents, other family members, friends, and even the designated beneficiary (child) may contribute to an ESA for the same child, but the total contributions for a child for a taxable year cannot exceed $2,000. Eligible taxpayers may contribute up to $2,000 for multiple children in a year.
Almost anyone can contribute to an ESA.
- Individuals of any age
- Individuals without earned income
- Individuals with modified adjusted gross income (MAGI) within the applicable limits for their tax filing status
There are two key limitations.
- Each child can receive up to the maximum contribution amount allowed per year ($2,000 per year) from all sources. It does not matter if this is done in a single account or in multiple accounts designed to benefit the same child.
- Contributors may be limited in how much they contribute if their MAGI exceeds $95,000 (for single filers) or $190,000 (for married tax filers). Above these income levels, the ability to contribute is phased out. An individual may not make an ESA contribution if her MAGI exceeds $110,000 for single tax filers or $220,000 for married tax filers.
A qualified education expense is one that is required for the enrollment or attendance by your child at an eligible educational institution.
These expenses include the following.
- Academic tutoring
- Special needs services
- Room and board expenses