ROTH IRAs: Everything You Need to Know

Follow the rules, and you’ll get tax-free qualified withdrawals at retirement

Saving for retirement is about more than growing your nest egg: It’s also about gaining an edge when it’s time to take your money out. And that’s where the Roth IRA shines.

The Roth IRA is an individual retirement account that comes with perks that traditional IRAs don’t offer. The biggest benefit of the Roth IRA is how tax-friendly it is. Although you can’t take a tax deduction on Roth IRA contributions, the money you sock away has the potential to grow tax-free as long as they stay in the account, and qualified withdrawals are tax-free, provided you follow the withdrawal rules. A Roth IRA will give you a tax-free income stream in retirement. You can keep more of what you earn.

Retirement savers are getting the message. The percentage of U.S. families with assets in a retirement account grew from 50.5 percent in 2019 to 54.3 percent in 2022 and a sharp increase in Roth IRA ownership was a key factor.

“Having sources of tax-free income in retirement makes more of your retirement dollars available for lifestyle expenses,” says Rob Burnette, chief executive officer at Outlook Financial Center in Troy, Ohio. “The old adage ‘It isn’t what you make that is important, it’s what you keep’ certainly applies to the Roth IRA.”

Another major benefit: You don’t have to take the required minimum distributions (RMDs). The IRS requires holders of traditional IRAs to start taking RMDs by April 1 of the year after they reach age 73. With a Roth IRA, your money has more time to grow tax-free.

Since RMDs are never required in Roth IRAs, this enables better control of your retirement account drawdown rates and easier tax planning during retirement. Contrast that to a traditional pretax IRA which mandates RMDs at a certain age: This drawdown rate and excess taxation can drain traditional IRA accounts faster than planned, and no one wants to run out of money.”

That extra time you gain by not having to take withdrawals means both your principal and your earnings can take advantage of compounding, which has the power to transform a humble account balance into a much more sizable one if financial markets rise in value.

Contribution limits

For the 2024 tax year, the maximum contribution is $7,000, or $8,000 for those 50 or older who take advantage of the $1,000 catch-up contribution. You can contribute to a 2024 Roth IRA until the April 15 tax filing deadline in 2025. The contribution limits are adjusted for inflation each year.

It is recommended to max out your Roth IRA each year if possible. The reason? Mathematically, a Roth IRA will always be more beneficial than a pretax IRA if taxes remain the same or go up in the future. And most everyone agrees that taxes are going up in the future.

There’s one catch. How much you can contribute to a Roth IRA may be reduced or phased out to zero dollars, depending on your modified adjusted gross income, or MAGI in IRS parlance. MAGI is your adjusted gross income on your 1040 or 1040-SR tax form, minus certain deductions, such as student loan interest.

In general, married couples filing jointly can contribute the Roth IRA maximum in 2024 if their MAGI is less than $230,000. Higher earners will be able to contribute either a reduced amount or nothing at all. The MAGI cutoff to contribute the maximum to a Roth IRA if you are single, head of household or married filing separately in 2024 is $146,000.

Roth IRA — 2023 vs. 2024 contribution limits

Comparison chart of Roth IRA contribution limits for 2024 vs. 2025

Source: Internal Revenue Service, November 1, 2024

This is partially why considering a “Backdoor Roth IRA” could make sense to you.

Withdrawals

You may make qualified withdrawals (meaning tax-free and penalty-free) from your Roth IRA principal (the money you’ve contributed to the account) at any time. Withdrawals from your account earnings are qualified if you are older than 59½ and have held your Roth IRA for at least five years.

If you are under 59½ and do not meet the five-year test, withdrawals from your earnings could be subject to income taxes as well as a 10 percent IRS penalty. The IRS figures that you’re taking out your principal first, but if you withdraw all your principal, further withdrawals generally are not qualified.

There are some exceptions. For example, you can take penalty-free (but not tax-free) withdrawals from your Roth if you’ve had it less than five years under certain conditions:

• You’re using up to a $10,000 lifetime maximum for the first-time purchase of a home.
• You’re using the withdrawal for qualified education purposes.
• You’re using the withdrawal for qualified expenses related to a birth or adoption.
• You suffer a disability or die.
• You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.
• You will still owe taxes on the earnings you withdraw.

Happy heirs

The dual advantages of tax-free withdrawals and no RMDs benefit retirees in additional ways. These perks make it easier and more tax-efficient to leave money to your heirs.

Roth IRAs are a great wealth transfer vehicle for people who are already retired. In fact, they enable you to transfer wealth tax-free.

Let’s say you have a granddaughter in her late 30s with a good-paying job that puts her in a high tax bracket. You want to leave your Roth IRA to her. Provided you opened the account at least five years before your death, she can benefit from tax-free withdrawals from the inherited balance.

Inherited Roth IRAs may have RMDs, depending on whether the beneficiary is a spouse or not. Consult a tax expert if you inherit a Roth IRA.  

The beauty of the Roth IRA is if Grandpa has money in a Roth and continues to save and invest, when the money is handed over to the grandchild, the inheritor can take the money as their own, and any withdrawals are totally tax-free. The wealth transfer happens without the IRS getting their hands on the money.

Cash-flow options

Having tax-free income from a Roth IRA also provides cash-flow options. Where does the Roth IRA come in? If you can take tax-free withdrawals from your Roth IRA, you can push out the date you start taking Social Security and take advantage of the annual boost to your benefit payment.

There’s no other investment that guarantees an 8 percent return like delaying Social Security does. What’s more, by taking income from your Roth IRA to meet your cash needs, you won’t inadvertently put yourself in a higher tax bracket, as you might if you pulled cash from a traditional IRA or 401(k), which are taxed at normal income rates.

The Roth IRA is a great way to bridge the income gap from the day you retire until the day you take Social Security.

If you hold a traditional IRA, converting to a Roth IRA might make financial sense. Money you withdraw from a traditional IRA to open a Roth can be taxed, but the tax hit is smaller when the returns on your IRA investments are down.

Generally speaking, the best time to do a Roth IRA conversion is when you have “a dip” in your taxable income or your taxable income is negative for some reason. These so-called low tax years can occur when you are well into retirement and your income is lower, for example, or when a onetime event takes a bite out of your taxable income, such as a massive medical deduction or a large business loss.

We all have different family, life, and professional situations. All should be taken into account when deciding to add this type of structure to your savings arsenal. Please know that we intend to take these individual situations into account, along with the input of your CPA and Trust attorneys, when discussing if the use of ROTHs are appropriate for you.

 - Tower 68 Financial Advisors - Newport Beach | Phoenix, AZ

Important Information:

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.