The author and financial advisor Suze Orman once said, “I love the Roth IRA. Tax-free income in retirement is a truly great deal.” Many investors, young and old alike, justifiably share her opinion. Most people want to work for as long as they can (or as long as they have to) and then retire comfortably in their golden years, focusing on their families. Ergo, when it comes to thinking about the distant (or not so distant) future, financial planning is of the utmost importance. There are many ways to do this, with traditional IRA and Roth IRA accounts being the most common. 

In this article, we’ll go into what a Roth IRA account is and some of its advantages over traditional IRAs. Also, we’ll examine what the Roth IRA contribution limits are for 2021 based on a few different factors.

What is a Roth IRA?

A Roth IRA is an individual retirement account that permits qualified withdrawals on a tax-free basis, provided certain conditions are met. It was named for the former Delaware senator William Roth and was introduced as part of the Taxpayer Relief Act of 1997. Though similar to traditional IRAs, the biggest difference that separates Roth IRAs is how they are taxed. 

Roth IRA contributions are made with dollars that have already been taxed, and the contributions aren’t tax-deductible. But once you begin to withdraw funds, the money is not taxable. This distinction is the most significant between Roth and traditional IRAs. With traditional IRAs, funds are usually contributed using pretax dollars. You then typically receive a tax deduction on your contribution and are charged income tax when you elect to pull the money from the account during retirement. The fact that Roth IRAs aren’t taxable isn’t the only benefit that they provide.

Benefits to Investing in a Roth IRA

Retirement Income That’s Tax-Free

The tax benefits of a Roth IRA are one of the main reasons to open an account. The key here is the source of the funds. Because you fund a Roth IRA with money that has already been taxed (meaning you can’t claim a deduction for contributions), the IRS doesn’t tax the money as you withdraw from the account (as long as certain conditions are met), including any gains you’ve made on your investments.

Quick and Simple Access to Funds

If you were to take money from a traditional IRA before the age of 59.5, you’d be slapped with an income-tax bill and be forced to pay a 10% penalty for early withdrawal (with some exceptions). This withdrawal process is different from a Roth IRA in that, provided the money you withdraw is from your contributions and not your earnings, you won’t be stuck with taxes or penalties (with some exceptions). Knowing that you can withdraw this money in case of an emergency is a comfort in and of itself. Plus, spending your own contributions, counts as a return of your own income. When qualifying for potential healthcare subsidies, this won’t be counted as taxable or tax-free income. This could possibly allow you to bridge the gap between early retirement and Medicare by structuring your sources of income.  

Looser Withdrawal Rules

Piggybacking off the previous point, when you withdraw money from your Roth IRA is really up to you; this is not the case with a traditional IRA, which necessitates required minimum distributions (RMD). At age 72, regardless of other factors (like market conditions and personal circumstances), investors are forced to begin withdrawing funds from their traditional IRA. Failing to do so could trigger a stiff 50% penalty on the amount you did not withdraw. 

With a Roth IRA, investors are free to keep their investments in the account as long as they are alive, which is a nice perk when factoring that the account is tax-free. It also prevents investors from being forced to sell in suboptimal market conditions to satisfy their RMD.

Allows You to Leave Something Behind

Many retirement accounts like traditional IRAs and 401ks pass down the taxes on withdrawals to inheritors. So, if you leave behind a traditional IRA for one of your heirs, he or she will be forced to pay taxes on any withdrawals. That’s not the case with a Roth IRA. If someone inherits a Roth IRA, they are allowed to make withdrawals without being taxed. 

Roth IRA Contribution Limits for 2021

For 2021, the deadline was extended to May 17th for IRA contributions. There are a couple of factors that determine how much you can contribute to your Roth IRA in any given year. Your income and your age are the two factors that determine your maximum contribution. For eligibility to contribute the maximum amount for 2021, your modified adjusted gross income must be less than $125,000 if single or $198,000 if married and filing jointly. If that’s the case, then your age is the next factor. The maximum amount you are allowed to contribute to a Roth IRA for 2021 is $6,000 if you’re younger than age 50, and if you’re 50 or older, you can put in an additional $1,000 per year, bringing the total contribution to $7,000. 

Roth IRA – Sound Financial Decisions  

There are a whole host of benefits to opening a Roth IRA. It’s tax-free, you can withdraw the money at almost any time without a penalty, and you can pass its benefits onto your heirs with ease. Now that you know what a Roth IRA is, its benefits, and the Roth IRA contribution limits you can make in 2021, you have all the information you need to decide if you want to open one. 

Learn about strategizing your holdings, click the link to see my video on the Tax Control Triangle strategy.