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Should I Contribute to a Roth IRA?

When starting to invest in your retirement, one common question people ask is “should I contribute to a Roth IRA? Find out the case for and against a Roth IRA.

3 min read

When choosing between a traditional IRA and Roth IRA, there are certain situations when it makes sense to have a Roth IRA. A Roth IRA allows workers to put post-tax money in their retirement account, and let it grow tax-free. You won’t owe taxes on the accumulated savings or when you take a distribution in retirement.

If you qualify to contribute to a Roth IRA, you can take advantage of Roth IRA benefits to grow your retirement savings. Some of the reasons why you should contribute to a Roth IRA include fewer restrictions, flexible early withdrawal options, tax diversification, and flexible timing for contributions. If you expect your earnings in retirement to be higher, hence a higher tax rate, you should consider rolling over your money to a Roth IRA.

Who Can Contribute to a Roth IRA?

There are two main requirements that savers must meet to start contributing to a Roth IRA

Earned income

The IRS requires that Roth IRA contributors must have earned income from a job, a term known as "taxable compensation". If you are a student who wants to save the extra money left from your parent's money, you are not eligible for a Roth IRA account. You must have taxable compensation from employment and meet the income requirements to be eligible for this retirement account.

The maximum a retirement saver can contribute to a Roth IRA in 2021 is their total income from work, or up to $6,000 for those under 50, or $7000 for those above 50 years.

Income limit

The IRS also restricts Roth IRA contributions based on their incomes. For 2021, your modified adjusted gross income (MAGI) in 2021 is $140,000 for single filers ($139,000 in 2020), or $208,000 for married filing jointly ($206,000 in 2020). Affluent investors with incomes exceeding $140,000 (single filers) and $208,000 (married filing jointly) cannot contribute to a Roth IRA.

Roth IRA vs. Traditional IRA: How Do They Compare?

Both Roth IRA and traditional IRA have tax advantages that make them preferred as retirement products. However, these two retirement accounts have different tax treatments.

A traditional IRA is funded with pretax dollars, meaning that you do not pay taxes on the contributions you make to the account. The money will grow tax-free, until when you decide to withdraw. You will be required to pay income tax on the original investment, and the returns earned over the years.

A Roth IRA is different from a traditional IRA. You contribute post-tax money into the account, meaning that the money you invest in the retirement account has already been taxed at the ordinary tax rate. The money grows tax-free, and you can withdraw money without paying income taxes or early penalty withdrawals, as long as you’ve held the account for at least five years.

Why Roth IRA is preferred by Retirement Savers

A Roth IRA has various benefits that make it desirable among young and aged workers. Here is why a Roth IRA may be better than other retirement plans:

Flexible early withdrawals

Most retirement accounts like 401(k) and traditional IRA discourage early withdrawals, and account holders may be forced to pay a 10% penalty tax in addition to income taxes when they make an early withdrawal.

A Roth IRA allows contributors to make an early withdrawal before reaching retirement age, without paying the 10% penalty tax or income taxes. However, the withdrawal is limited to the actual contributions put into the account and not the earnings accumulated in the account. If you have a long way before going into retirement and you want to access your money when you need it, a Roth IRA might be what you need.

Fewer restrictions

Traditional IRA and 401(k) require account holders to take a mandatory distribution when they reach age 72. There is a 50% penalty if you do not take the mandatory distribution.

A Roth IRA works differently, and it does not have minimum distribution rules. Contributors can opt to have the retirement money continue growing even after attaining age 72, and the IRS will not impose a penalty for doing so.

Tax diversification

A 401(k) and Roth IRA have different tax treatments, and you can choose to contribute to both types of retirement accounts to enjoy the benefits of both worlds. If your employer offers a 401(k) retirement plan with an employer’s match, you should contribute the highest amount to maximize your employer’s match.  

You can also open a Roth IRA with a bank or credit union, and divert part of the retirement savings to your new retirement account. You can maintain both accounts to enjoy the tax benefits of both retirement accounts while minimizing your tax burden in retirement.

You expect to be in a higher tax bracket in retirement

When you start working, your effective tax rate will likely be in the lower brackets. As your salary increases over the years, your income will be pushed to a higher tax bracket, and possibly, you will be in a higher tax bracket in retirement.

With a Roth IRA, you can pay income taxes now so that your contributions and earned interest grow tax-free. Also, you will owe zero taxes in retirement, and you will keep all the retirement savings you have accumulated over the years.

Flexible Timing

A Roth IRA allows workers to decide when and how much to contribute towards their retirement savings. If you plan to contribute $6,000 during the year, you can opt to pay this amount every month, quarterly, or as a lump sum. You have from the first day of the year until the tax deadline to make contributions for the previous year.

When NOT to Contribute to a Roth IRA

While a Roth IRA has multiple benefits over a traditional IRA or 401(k), certain factors make a Roth IRA less attractive to savers:

You are earning a higher income

If you are in your peak earning years, your income in retirement may be in a lower tax bracket. Therefore, you can postpone paying higher taxes now and opt to pay income taxes in the future when the effective tax rate is lower. The savings and investment earnings will grow tax-free, and you will only pay taxes when taking a distribution.

No IRA loans

A Roth IRA does now allow account holders to take a loan on their retirement savings, as is the case with 401(k). 401(k) participants can take a 401(k) loan up to $50,000, instead of withdrawing their savings. However, Roth IRA participants do not have a loan option; instead, they can choose to withdraw some of their contributions at zero penalty or taxes.