Open a Roth IRA Today or Regret It Later

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Roth IRAs are amazing tax saving tools. Roth IRAs allow investors to grow their money tax-free. Even though there is no deduction for contributions, a Roth IRA provides the dual benefits of tax-free accumulation and tax-free distributions after age 59 1/2. The long-term benefits can be significant.

We suggest you fund your Roth IRA even when you can’t afford it and that you use taxable savings as your seed money.

Roth IRAs have one weakness. They are subject to the 5-Year Roth Rule.

The remedy for this weakness is to have opened and funded your Roth more than 5 years ago. Don’t wait. Open and fund your Roth today!

You can always withdraw whatever you contribute to a Roth IRA without tax or penalty. Contribute $10 today, and you can take your $10 basis out at any time regardless of your age, your Roth IRA’s age, or the reason for the distribution and owe no tax.

Conversions, rollovers, and earnings however are all subject to a version of the five-year rule.

For the distribution to be without the 10% penalty, you need to meet one of the following:

  1. Your distribution is from a contribution basis.
  2. Your distribution is made from your conversion basis after the 5-year period beginning after the conversion.
  3. Your distribution from your earnings counts as a qualified distribution (described below)
  4. You meet an exception.

The exception list is:

  • You have reached age 59½.
  • You are totally and permanently disabled.
  • You are the beneficiary of a deceased IRA owner.
  • You use the distribution to buy, build, or rebuild a first home.
  • The distributions are part of a series of substantially equal payments.
  • You have unreimbursed medical expenses that are more than 10% (or 7.5% if you or your spouse was born before January 2, 1952) of your adjusted gross income (defined earlier) for the year.
  • You are paying medical insurance premiums during a period of unemployment.
  • The distributions are not more than your qualified higher education expenses.
  • The distribution is due to an IRS levy of the qualified plan.
  • The distribution is a qualified reservist distribution.

For the distribution from your earnings to be tax-free, it needs to be a qualified distribution which means you need to meet both of the following:

  1. A Roth IRA of yours has been set-up for at least 5 years.
    AND
  2. The payment or distribution is:
    1. Made on or after the date you reach age 59½,
    2. Made because you are disabled (defined earlier),
    3. Made to a beneficiary or to your estate after your death, or
    4. One that meets the requirements listed under First home under Exceptions in chapter 1 (up to a $10,000 lifetime limit).

This is one of the few weaknesses of a Roth IRA. Withdrawals may not be entirely tax free in the account’s youth.

Now, this weakness is easily overcome: CONTRIBUTE TODAY! CONVERT TODAY!

Once you have had one Roth IRA for five tax years, the requirement is satisfied for all of your earnings in all Roth IRAs regardless of how long particular contributed dollars have been in a particular account.

Conversions have their own five-year clock, but the IRS “Ordering Rules for Distributions” means that if you have money in your Roth IRA that has its five-years satisfied, the chance of any new conversion’s youth mattering is very small. If its youth does matter, then “Unless one of the exceptions listed later applies, you must pay the 10% additional tax in the year of the distribution,” but one of the exceptions is “You have reached age 59½.”

Fund your Roth or convert some now to get the 5-Year clock started so that you can enjoy a lifetime of tax-free distributions.

If you have earned income this year, open a Roth IRA, and contribute at least $1.

Have a working spouse? You can both fund your IRAs so long as one of you has earned income.

Do your children have earned income? Babysitting, lawn mowing, or any other job? Fund accounts for them! Here’s an article “How to Open a Roth for Your Child”, and the answer to “Do Children Need To File A Tax Return To Fund Their Roth IRA?”

No earned income but you have a traditional IRA? Convert to some to a Roth.

If you are still reading this article, stop, open, and fund your Roth IRA now. You may regret it later if you don’t.

Photo by Dennis Klein on Unsplash
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Megan Russell has worked with Marotta Wealth Management since 2005. She loves to find ways to make the complexities of financial planning accessible to everyone. Her most popular post: The Complete Guide to Your Washing Machine