What should you know about Roth IRAs?

April 12, 2020

A Roth IRA is a retirement account that you contribute to with dollars that are after-tax dollars.  Because you have already paid tax before making the contribution, you do not receive a current year tax benefit for having made the contribution.  As a result, invested contributions have the ability to grow over time on a tax deferred basis, meaning you do not pay income taxes on the growth year after year. 

When you reach the point when you are ready to take distributions at retirement, you can take distributions in the amount of your choice and distributions can be used income tax free.  Unlike a traditional IRA, you are not required to take a Required Minimum Distribution when you reach 72 in the amount specified by the government.  

Contributions to a Roth IRA are always available for withdrawal and can be tapped into for other purposes.  Interest/investment earnings are still subject to taxes and penalties.  There are limits on who can contribute to a Roth IRA based on income, but for those over the limit, a Backdoor Roth can be utilized by contributing to a pretax IRA without income tax deduction benefits and then converting to a Roth IRA.  You may take nontaxable withdrawals before age 59½ if the Roth IRA is held for at least five years and you meet certain distribution guidelines. Otherwise, an early withdrawal before age 59 ½ may be subject to taxes and a 10 percent federal tax penalty. Please discuss with your tax advisor prior to making financial decisions.

Non-Retirement Uses your Roth IRA:

-Qualified Education Expenses; Roth IRA money is not considered for the FAFSA, so your student may qualify for more financial aid if you using a Roth as a funding mechanism, instead of a 529 plan (Contributions only)

-Up to $10,000 from your Roth IRA can be used for the purchase of a home, $20,000 for a married couple ($10,000 from each; Contributions and Earnings)

-Wealth distribution; if your children inherit your Roth IRA, they also can take distributions income tax free

This is meant for educational purposes only.  It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions.  Waddell & Reed does not offer tax advice.  (04/20)