A Roth IRA is a great vehicle for saving for retirement. Because you pay taxes on money going into your account, you can withdraw funds tax-free in retirement. And unlike other retirement funds, required minimum distributions don’t apply to Roth IRAs, so your money can grow tax-free for as long as you like. To be sure you’re getting the most from a Roth IRA account, this article will go over some common — and sometimes costly — mistakes people make with their Roth IRAs.
Don’t Skip a Roth IRA Just Because You Already Have a 401(k)
You might be tempted to skip a Roth IRA if you already have a 401(k), but this savings combination can help accrue a considerable nest egg. To take full advantage of both retirement plans, be sure you’re contributing enough to your 401(k) to get the full employer match, if your employer participates in a match program. Once you’ve maxed out your contribution to the employer match, open a Roth IRA and begin funding it.
Don’t Contribute If Your Income Doesn’t Allow You to Qualify
For 2022, married couples filing jointly can contribute to a Roth IRA if your modified adjusted gross income (MAGI) is $204,000 or less ($129,000 for single filers). Contributions begin phasing out above those amounts, and you’re not permitted to contribute to a Roth IRA once your income reaches $214,000 if married and filing jointly ($144,000 for single filers).
If you make contributions when your income places you above the contribution limit, it’s considered an excess contribution. The IRS will charge a 6% tax on the excess amount for each year it remains in your account.
Don’t Contribute Too Much
Just as with income limits, if you deposit more than you’re permitted to contribute to your Roth IRA, you’ll be subject to the same 6% excise tax on the extra funds every year until the overage is corrected. If this slip-up endures for a few years, it has the potential to be costly. To fix this problem, you have until your tax filing deadline to withdraw the excess funds without facing the penalty. Just be sure to also withdraw the interest and any other income generated from those surplus funds.
Don’t Discount a Backdoor Roth IRA
For those earners whose incomes fall above the Roth IRA limits, you have the option of a backdoor Roth IRA. Using this strategy, after-tax contributions are made to a traditional IRA, then the invested money is converted to a Roth IRA. However, because funds deposited into a traditional IRA are pre-tax, expect to pay income tax on the conversion. This move even has the potential to bump you into a higher tax bracket, so it’s never a bad idea to consult a tax professional when you’re considering a backdoor Roth IRA.
Don’t Miss Out on a Spousal IRA
A spousal IRA is an exception to the condition that an individual must have earned income to contribute to an IRA. It permits a working spouse to contribute to an IRA in the name of a spouse who has no income or very little income. Provided the working spouse’s income equals or surpasses the total IRA contributions made on behalf of both spouses, this is a strategic approach to investing.
Depending on your income, your maximum contribution to a spousal IRA is $6,000 each, which increases to $7,000 per person at age 50. So if you’re 51 and your spouse is 49, you’re able to contribute $13,000. Once your spouse reaches age 50 you can begin contributing the maximum $14,000.
Don’t Do Rollovers Without Knowing the Rules
When you do a rollover — withdraw money from one retirement account and deposit it into another — you need to abide by certain rules in order to avoid tax consequences. For instance, if you withdraw funds from a retirement account like a 401(k), you have 60 days to deposit the full amount into your Roth IRA. Neglecting to do so will render the withdrawal a taxable distribution, and may also be subject to a 10% additional early-distribution tax. Also be aware that typically only one rollover per year is permitted.
You can also choose to do a direct rollover where all or a portion of your retirement funds are directly transferred from one qualified retirement plan to another. This move is not taxable, so you can move your money without facing tax penalties, and your money continues to grow tax-deferred until you make withdrawals. However, keep in mind that your contributions to a 401(k) or traditional IRA were pre-tax, so when you roll them into a Roth IRA, they’ll count as income in the year you made the rollover.
Don’t Forget About Beneficiaries
If you neglect to name a living beneficiary for your Roth IRA, the money typically will need to go through probate before your heirs gain access to it. Going to probate means that all your assets, including your Roth IRA, are lumped together, and all debt is paid before the funds are distributed to heirs. This, of course, means that your heirs may not end up with as much as you’d planned. Be sure your named beneficiaries are up to date.
Don’t Just Sit on Your Funds
You have to make contributions to your Roth IRA if you want to take advantage of the tax-free growth and compound interest. You also need to decide how you want to invest those funds. If investment strategy isn’t your strong suit, consider working with a financial professional.
