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Roth IRAs: The Complete Guide
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Funding a Roth IRA

A Roth individual retirement account (Roth IRA) is a terrific way to save for retirement. While you don’t get an up-front tax break, your contributions and earnings grow tax free. And when you later take qualified distributions, they’re also tax free. If you expect to be in a higher tax bracket in retirement than you are now, or if you just don’t want to worry about any taxes, this vehicle can be a smart tax strategy.

Key Takeaways

  • If you’re eligible for a Roth individual retirement account (Roth IRA), you can contribute up to $6,000 a year. If you’re 50 or older, you can make an additional $1,000 catch-up contribution.
  • Roth IRAs have income thresholds that determine if you can contribute.
  • You can open a Roth IRA at many financial institutions and arrange to fund it automatically.
  • You can also fund a Roth IRA by moving money into it from another retirement account.
  • It is possible to convert a traditional IRA into a Roth IRA.

How to Open and Fund a Roth IRA

Before you can fund a Roth IRA, you have to open an account. Nearly all financial institutions—including banks, mutual fund companies, and brokerage firms—offer Roth IRAs. For the sake of convenience, you might want to open your account at a financial institution with which you already do business.

Before you apply, make sure that you’re eligible for a Roth IRA. Roth IRAs have income phaseout ranges and maximum thresholds that can block some high-income earners from eligibility. Moreover, you may be eligible to make contributions one year but not the next due to your annual salary.

Income earners below the threshold levels generally will have no problem. In most cases, you can take care of the account application easily online. You will just need the following:

  • A driver’s license (or some other photo ID)
  • A Social Security number
  • Banking details for funding, including a routing number and an account number
  • Details on beneficiaries

Once your application is approved, you can usually make your first contribution with cash, a check, or a bank transfer. To simplify matters, you also can arrange for future contributions to come regularly and automatically out of your checking account or other sources through automation. The contribution limits may change periodically, but they are not a part of the annual inflation adjustments by the Internal Revenue Service (IRS). Thus, for 2022, you can contribute up to $6,000 to a Roth IRA—or $7,000 if you’re age 50 or older; the same applies for 2021.

How to Fund with a Roth IRA Conversion

Another way to fund a Roth IRA is to transfer money from an existing retirement account. This is known as a Roth IRA conversion. You can move money into your Roth IRA from these sources:

  • Traditional IRAs
  • Employer-sponsored 401(k) or 403(b) plans
  • Government 457(b) plans
  • Simplified Employee Pension (SEP) IRAs
  • Savings Incentive Match Plan for Employees (SIMPLE) IRAs

Keep in mind that a Roth conversion is usually a taxable event. When you move money from a taxable retirement account (such as a traditional IRA) to a Roth, you’ll owe income taxes on the conversion amount.

In general, it can be a good idea to save a conversion for a year when:

  • You earn too much to contribute to a Roth directly
  • You are expecting a prolonged higher tax bracket in future years
  • The taxable account from which you’re moving funds has suffered losses (a lower balance means that you’ll owe less tax at conversion time)

If you plan to fund your account through a Roth IRA conversion, remember that you probably will have to pay income taxes on that money.

Make Retirement Savings Automatic

You have until the tax year’s filing deadline to contribute to your Roth IRA. For tax year 2021, that’s April 18, 2022. But you don’t have to wait until then. You can add money to your account as early as Jan. 1 of the current tax year. Funding your account as early as possible means that your money will have that much longer to grow, tax free.

You can make one large contribution—at any point between Jan. 1 and mid-April of the following year—if you have the cash on hand to do so. For many people, however, it’s easier to make several smaller contributions throughout the year.

If you do that, it’s wise to set up a Roth IRA contribution schedule. Decide if you want to contribute weekly, monthly, quarterly—whatever works best for you—and mark those dates on your calendar or set reminders. Of course, that can be a lot to keep track of. Fortunately, as mentioned earlier, you can arrange for automatic transfers from your bank so that you don’t forget to invest. Check your Roth IRA provider’s website for how to go about it.

No matter how you fund your Roth IRA, try to make it a habit, and start as early as possible. For example, if you open a Roth IRA when you’re age 20, contribute $6,000 a year until age 65, and your account earns an average of 8% a year, then you’ll have more than $1.7 million heading into retirement. And it will all be tax free.

What Are the Advantages of Roth IRAs?

Roth IRAs have other perks as well. Unlike traditional IRAs, you don’t have to take any required minimum distributions (RMDs) during your lifetime. So if you don’t need the money for living expenses, you can just leave it in the account to grow. You can then pass your entire Roth IRA to your beneficiaries, providing them with years of tax-free growth and income, which has been limited by the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.

The SECURE Act made broad changes to retirement legislation. The law effectively ended what was known as the stretch IRA, which allowed beneficiaries of IRAs to spread out their inherited asset withdrawals—and therefore the tax burden—over their lifetime. It also allowed more time for asset growth. The distribution time frame has now been limited to 10 years, with some exceptions.

Roth IRAs also had a benefit over traditional IRAs: no age cap for contributions. Traditional IRAs limited contributions up to age 70½, but under the SECURE Act, this age restriction has been eliminated.

What Are the Income Limits for Roth IRAs?

The IRS has certain income requirements for Roth IRAs, which can be important to follow for high-income earners. The income levels change annually with inflation adjustments.

For 2021, the IRS’s Roth IRA income phaseout ranges are as follows:

  • $125,000 to $140,000 for singles and heads of households
  • $198,000 to $208,000 for married couples filing jointly
  • The phaseout range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains (as in 2020) $0 to $10,000.

The phaseout ranges for 2022 are:

  • $129,000 to $144,000 for singles and heads of households
  • $204,000 to $214,000 for married couples filing jointly
  • The phaseout range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains (as in 2021) $0 to $10,000.

How to Calculate Your Reduced Contribution

With these phaseout ranges, contributors below the minimum threshold are allowed to contribute the full amount. Contributors within the threshold can only contribute a percentage of the contribution amount. Earners at or above the threshold cannot contribute at all.

In 2022, single, head of household, or married filing separately filers who earn $129,000 to $144,000 should use the following formula to calculate how much they can contribute to a Roth IRA:

  1. Subtract $129,000 from your modified adjusted gross income (MAGI).
  2. Divide the result by $15,000.
  3. Multiply the contribution limit ($6,000) by the decimal figure that resulted from the previous step.
  4. Subtract the contribution limit ($6,000) by this figure. This is your reduced contribution limit.

Let’s say that a single filer made $140,000 in 2022.

  1. $140,000 - $129,000 = $11,000
  2. $11,000 ÷ $15,000 = 0.73
  3. 0.73 × $6,000 = $4,400
  4. $6,000 - $4,400 = $1,600

Thus, a single filer earning $140,000 will be able to contribute $1,600. For more information on calculating reduced limits for married filers, see the IRS website.

Can I fund a Roth individual retirement account (Roth IRA) with cash?

If you opened your Roth individual retirement account (Roth IRA) at an institution that has physical locations and the ability to accept cash, then absolutely. Since many banks offer Roth IRAs, this is a possibility. Much more commonly, you can fund your Roth IRA by using a bank transfer.

Do you have to bank at the same location as your Roth IRA?

No. While many banks offer Roth IRAs, you can easily contribute to your Roth IRA through the website of whichever brokerage or firm you choose. They will transfer money from the verified account at your bank. Firms like Vanguard, Fidelity, or Charles Schwab offer easy-to-set-up contributions, either automatic or whenever you choose to invest.

Will I have to pay taxes on a Roth IRA conversion?

Yes. If you are funding your Roth IRA with a traditional IRA, funds from a 401(k) or other employer-sponsored plan, or a plan that reduced your taxable income in the year when you funded it, then you will have to pay taxes on the money being converted at the current tax rate.

The Bottom Line

Generally, Roth IRA administrators make it incredibly simple to fund your Roth IRA. With automatic contributions, you can easily fund your account in monthly installments or contribute a lump sum when you have it available. Although they incur taxes at the conversion time, Roth IRA conversions can also be a wise choice depending on your tax situation. Consult a financial advisor to assess the benefits and costs.

Article Sources

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