Roth IRAs and traditional IRAs are two of the most popular retirement plans available. Both offer tax benefits, but they are structured differently. A Roth IRA is funded with post-tax dollars and withdrawals may be able to be taken without penalty. You pay taxes on contributions before they go into your account, but then your money is tax-free when you withdraw funds from your account during retirement. If you’re willing to accept a smaller benefit now for a larger one later, then a Roth IRA might be right for you. The following guide will explain everything you need to know about Roth IRAs including how much money can be contributed each year, what happens if I need to take money out early?

Roth IRA definition

A Roth IRA is a type of savings account that you can use to save for retirement. It’s similar to other retirement plans, like the 401(k) and traditional IRA, but with some key differences.

How does a Roth IRA work?  A Roth IRA works in the same way as other retirement plans: You make contributions to grow your balance over time, which you can then withdraw at age 59½ or older without owing taxes on any earnings or gains (with some exceptions).

Who can open and fund a Roth IRA?

Roth IRA contributions can be made by anyone who has earned income and meets the following requirements:

• You are under age 70½.
• You have been a U.S. citizen or resident for at least five years.
• You have not already contributed the maximum amount to a Roth IRA in the current tax year, which is $6,000 for 2022 ($7,000 if you’re age 50 or older).

If your income is above certain thresholds, you may not be eligible to contribute directly to a Roth IRA.  Reach out to us about all those details.

What are the contribution limits for a Roth IRA?

The contribution limit for both Roth and traditional IRAs for 2022 is $6,000. If you are 50 or older, the contribution limit is $7,000.

Can I contribute to both a traditional IRA and a Roth IRA in the same year?

The short answer is no, you can’t contribute to both a traditional IRA and Roth IRA in the same year.  You are allowed $6000 per year.  Now you can divide that amount and put some in a traditional IRA and some in the Roth IRA but together you can’t contribute more then $6000 in any given year.

How much can I withdraw from a Roth IRA before retirement?

You can withdraw the money you contributed to your Roth IRA at any time, provided that the account has been open for at least five years.  First-time home purchase withdrawals. If you haven’t owned a home in two years, you can withdraw up to $10,000 from your Roth IRA to pay for a first-time home purchase.  And lastly, college expenses withdrawals: You can also use up to $10K from an existing account without penalty if it’s used towards tuition or related expenses—but only after meeting certain requirements (see above).

What happens if I need to withdraw money from a Roth IRA before age 59½?

The amount you withdraw is subject to ordinary income tax, but there are exceptions.

Earnings: If you’ve had the account open for at least five years, there’s no penalty as long as you’re over age 59½ at the time of withdrawal. You may also be able to avoid penalties by taking distributions from your Roth IRA and paying for qualified medical expenses or college tuition (if you’re a student), though these rules have strict requirements that aren’t always easy to meet.

Contributions: You can take out your contributions at any time without having to pay a 10 percent early withdrawal penalty.

Conclusion

A Roth IRA can be an advantageous way to save for retirement. It allows you to contribute up to $6,000 per year (or $7,000 if you’re 50 or older) and receive tax-free distributions in retirement. However, there are also some important rules to remember when it comes time to take money out of one of these accounts before age 59½.  Call and we are happy to chat with you about all the details and help you open a Roth IRA account today.

Risk Disclosure: Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance does not guarantee future results.

This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. The content is developed from sources believed to be providing accurate information; no warranty, expressed or implied, is made regarding the accuracy, adequacy, completeness, legality, reliability, or usefulness of any information. Consult your financial professional before making any investment decision. For illustrative use only.

Stephen Pease, David W. Smiley and Matt Hoaglin are Investment Advisor Representatives with Dynamic Wealth Advisors dba Oxford Financial Planners.  All investment advisory services are offered through Dynamic Wealth Advisors.