The Ultimate Roth IRA Guide

How Much Can You Contribute to a Roth IRA in 2022? 

The Roth IRA contribution limit for 2022 is $6,000. This is unchanged from 2021. If you are 50 and older then you can contribute $7,000. The contributions for a tax year must be made by the IRA owner’s tax filing date. This date is generally April 15 the following year. For example, to contribute towards tax year 2021, one has until April 18th, 2022 this year to do so. 

You must have earned income to be eligible for a Roth IRA. This includes salaries, bonuses, commissions, consulting gigs, and small business income. It is generally any amount that is shown in Box 1 on the individual’s Form W-2 or on a 1099.

What are the Roth IRA Income Limits for 2022?

You can’t contribute to a Roth IRA if you make too much money. The income limit has increased for 2022 so that means that more Americans can now contribute to a Roth IRA.  Based on your tax filing status and Modified Adjusted Gross Income (MAGI), the table below specifies how much you can contribute to a Roth IRA.

Amount of Roth IRA Contributions You Can Make in 2022

What are the Disadvantages of a Roth IRA? 

The major disadvantage of a Roth IRA is that they do not include an up-front tax break. This is also the major difference between a Roth IRA and a pre-tax 401(k). There is also no automatic payroll deduction so you need to make sure that you remember to contribute each year. 

Roth IRA vs Traditional IRA

The two major differences between a Roth IRA and a Traditional IRA are taxes and withdrawals.

Taxes:
– A traditional IRA is ideal for those who want an immediate tax break as contributions can be tax-deductible. However, you do have to pay taxes when you withdraw the money. 
–  A Roth IRA is a good choice if you’re not eligible to deduct traditional IRA contributions, or if you want tax-free growth on your investments. You do not have to pay taxes on your withdrawals.

Withdrawals:
– For a traditional IRA, you cannot take out the money before you’re 59 ½ years old. If you do then you’ll incur a 10% penalty and have to pay federal and state taxes.
– For a Roth IRA, you can take out any contributions that you have made without paying any taxes. However, this only applies to your contributions, not your earnings. 

If you expect your tax bracket to be higher in retirement, then a Roth IRA is usually more beneficial for you. Younger and lower/middle income individuals may benefit from a Roth IRA most.

Roth IRA vs Roth 401(k)

There are some major differences between a Roth IRA and a Roth 401(k) as outlined below.

• Income limits: Roth IRAs have income limits and Roth 401(k)s do not. 

• Contribution limits: For 2022, a Roth IRA has a maximum yearly contribution limit of $6,000 with an additional $1,000 catch-up contribution ($7,000 total) if you’re age 50 or olders. The Roth 401(k) contribution limit is $20,500 with an additional $6,500 catch-up contribution ($27,000 total) if you’re 50 or older.

• Required minimum distributions: Roth IRAs do not have required minimum distributions. You can leave the money growing tax-free for as long as you wish. Roth 401(k)s do have required minimum distributions. 

• Early withdrawals: For a Roth IRA, you are allowed to take out only your contributions anytime with no penalty and no tax. Early withdrawals for a Roth 401(k) can get messy. Generally, if your employer allows for in-service withdrawals then you can access your contributions tax and penalty-free. However, if you take the earnings out,  you may have to pay income tax as well as a 10% penalty. The problem with taking money from a Roth 401(k) is that early withdrawals are pro-rated and will be considered partially your contributions and partially your earnings. 

You can contribute to both a Roth IRA and a Roth 401(k) if your income allows. It’s best to speak with a certified financial advisor who can help you decide if contributing to both is best for your financial situation and goals. 

Spousal Roth IRA

A non-working spouse can contribute to a Roth IRA, as long as their household income meets the eligibility limit. These contributions are subject to the same rules and limits as regular Roth IRA contributions. This Roth IRA account will be separate from the working spouse’s Roth IRA account as Roth IRAs cannot be joint. 

Roth IRA Withdrawal Rules

There are Roth IRA withdrawal rules that you must follow. You can withdraw your Roth IRA contributions at any time without owing any penalties or taxes. Qualified withdrawals of earnings can be tax-free and penalty-free but it does complicate things with the IRS. Be careful doing this because you can be taxed if those withdrawals do not meet the ‘qualified’ definition.  

People who have had their Roth IRAs for at least 5 years and are at least 59½ years old can withdraw contributions and earnings without paying federal taxes.

Withdrawals that are not ‘qualified’ will be subject to income tax and/or a 10% early distribution penalty. There are some exceptions which include childbirth/adoption expenses, qualified higher education expenses, and medical insurance. 

The 5-Year Rule

The withdrawal of Roth IRA earnings may be subject to income taxes and a 10% early withdrawal penalty depending on your age and if you have met the five year rule. The five year rule means that you need to have contributed to a Roth IRA for at least 5 years.

If you meet the five year rule: 

• Under age 59½: Earnings are subject to taxes and penalties.  You may be able to avoid taxes and penalties if you use the withdrawal for a qualified expense. 
• Ages 59½ and older: No taxes or penalties.

If you don’t meet the five-year rule:

• Under age 59½: Earnings are subject to taxes and penalties. You may be able to avoid the penalty (but not the taxes) if you use the money for a qualified expense. 
• Ages 59½ and older: Earnings are subject to taxes but not penalties.