The Roth IRA was established by the Taxpayer Relief Act of 1997 and named after one of its chief proponents, Senator William Roth of Delaware. The primary difference between a Roth IRA and a Traditional IRA is that contributions to a Roth IRA are non-deductible and the withdrawals from the Roth, if certain conditions are met, are tax-free. The benefit of tax-free growth forever is fantastic and cannot be emphasized enough, and thus the Government has introduced a number of requirements that must be met in order to be eligible to contribute to a Roth IRA.
The first requirement is that an individual must have earned income for the tax-year for which the Roth IRA contribution is for. An individual is eligible to contribute 100% of earned income up to $6,500 if under the age of 50 and $7,500 if over age 50 (2023 figures). The additional $1,000 of eligible contributions for people over the age of 50 is known as a “Catch-up contribution”. Earned income is defined by the IRS as “all the taxable income and wages you get from working or from certain disability payments”. Prior to contributing to a Roth IRA, it is important to double check your earned income is at least equal to, or greater than, your planned contribution amount. If you are a parent of a teenager who is about to start their first job, a possible opportunity to set them up for a strong financial future as well as teach them about investing is to open up a Roth IRA for them. The child can contribute a certain percentage of their paycheck and the parent can either match the contributions or contribute the maximum allowable amount. Since the Roth IRA grows tax-free and the child has time on their side, modest contributions when the child is young can grow to vast sums down the road.
The second condition that must be met is based on income. The Government has instituted income limitations on taxpayers to contribute to a Roth IRA. For single tax filers in 2023, the income phase-out where the maximum contribution is limited, eventually reaching zero, starts at $138,000 and ends at $153,000 for your Modified Adjusted Gross Income. Thus, if you’re a single filer and make more than $153,000 in 2023, you are ineligible to contribute to a Roth IRA. For married filing jointly and qualifying widowers, the income phase-out begins at $218,000 and ends at $278,000.
For everyone who is ineligible to make a direct Roth IRA contribution due to the income limitations, there is a loophole in the system that is known as a Backdoor Roth. As the tax-code is currently structured, it allows an individual to make a non-deductible contribution to a Traditional IRA and then convert the Traditional IRA to a Roth IRA. There are no income limitations with an IRA conversion and no annual limits to the amount that can be converted. An individual is eligible to convert as much of their Traditional IRA to a Roth as desired. However, there are a few things that must be considered prior to the conversion. Check out our blog post on Roth Conversions to learn more about when you should consider doing one.
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Last updated January 9, 2023
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