2021 Guide to the Roth IRA

One of the best ways to put away money for your retirement is with a Roth IRA. A Roth IRA differs from a traditional IRA in that a Roth IRA lets your money grow tax-free, plus allows for tax-free withdrawals. Knowing that, it’s easy to understand why this is such a popular savings option for so many people. But, as with any type of retirement plan where contributions and distributions are part of the mix, the IRS has a complex set of rules that can be ever-changing from year to year. To make sure you understand the Roth IRA rules for 2021 and beyond, here are some key points you should keep in mind.

Earned Income and the Roth IRA

For starters, always remember that only income that meets the criteria of being earned income can be contributed to a Roth IRA. Thus, it seems like you must either work for someone else or have your own business to have that income eligible for Roth IRA contributions. However, certain other forms of income such as untaxed combat pay, military differential pay, and even alimony that is taxed will be looked at as earned income for Roth IRA contributions. 

As for what won't be seen as earned income by the IR; this includes money earned from investments such as stocks or rental property, Social Security and unemployment benefits, child support, and alimony that is nontaxable.

Age Limits for Roth IRA Contributions

Along with its tax-free advantages, a Roth IRA has no age limits when it comes to contributions. Thus, whether you are well away from retirement age or already in your golden years and want to continue working at your job or business, the IRS will still let you contribute income to your Roth IRA.

Also, it's important to remember that if you are like other people and have multiple retirement accounts, you can still contribute to your Roth IRA. Thus, should you be employed and participate in a company's 401(k) plan, you can contribute to this and to your Roth IRA simultaneously.

High Earners are Restricted

With a Roth IRA, those who have a high amount of earned income may be restricted from what they can contribute, or may in fact not even be eligible to contribute to a Roth IRA. Since income levels for this are generally adjusted by the IRS on a yearly basis, it's important to speak to your CPA to make sure you meet the requirements. 

When determining eligibility, the IRS uses both your tax filing status and modified adjusted gross income. In 2021, couples who file jointly and have an income not exceeding $198,000 can make the maximum contribution of $6,000 to their Roth IRA, or $7,000 if they are above age 50. For single individuals or those whose tax status is head of household or married filing separately, the maximum income level drops to $125,000, but the contribution limits remain the same.

Timing Your Contributions

Since you want the income you contribute to your Roth IRA to get maximum results, it's important to know how timing your contributions can make this happen. For starters, contributions to your Roth IRA can be made all the way up until the tax filing deadline for the next year. Thus, if you want to make contributions to your account for 2021, you will have until April 15, 2022 to do so. However, if you obtain a filing extension for your taxes, this will not give you additional time to contribute to your Roth IRA. 

Can You Get Tax Breaks on Roth IRA Contributions? 

Generally, Roth IRA contributions are not designed so that you can get an immediate tax deduction, since the contributions are not deductible in the same year in which you make them. However, depending on such factors as your annual contribution, adjusted gross income, and filing status, you may be able to qualify for a tax break known as the Saver's Credit.

Offering as much as $1,000 in savings, the Saver's Credit has qualification limits for 2021. For single taxpayers, income levels must be less than $33,000, while head of household filers must have incomes of less than $46,500. As for those with married and filing jointly status, income levels must stay below $66,000.

Withdrawal Rules 

If there is one thing many people love about a Roth IRA, it is that the account has no required minimum distributions. Thus, you are allowed to withdraw contributions made to your Roth IRA whenever you choose and for any reason; all the while not having to worry about paying penalties or owing taxes.

Yet, when it comes to withdrawing your Roth IRA earnings, the rules are a bit different. With this, earnings can be withdrawn without paying penalties or taxes so long as you are at least 59- 1/2 years old and have had your Roth IRA for at least five years. But should you be less than 59-1/2, it is still possible to avoid taxes and penalties if you make a withdrawal on your earnings. But to do so, your withdrawal will need to be made due to you having a permanent disability or wanting to use the money to purchase your first home. Sound complicated? Talk to your CPA to determine how a withdrawal may impact you.

Contributions and Recordkeeping

Even though you are not required to report your Roth IRA contributions on your federal tax return, this does not mean you should not keep detailed records of your transactions. By doing so, you will be able to answer any and all questions should the IRS come calling, such as whether you have met the five-year rule for owning your account or other potential issues. Since you should receive Form 5498 from your Roth IRA custodian or trustee each year you make a contribution, this will make recordkeeping much easier. 

Due to rules constantly changing and the various complexities that go along with retirement accounts, never hesitate to consult with your CPA when you have questions about your Roth IRA. By doing so, you may be able to take advantage of tax credits and other opportunities to maximize your contributions.