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Roth IRA: How it works & why to consider it

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An individual retirement account (IRA) allows you to save for retirement in a tax-advantaged way. But a Roth version of an IRA has some special features that may make a notable difference in your retirement savings.

Here's what you should know.

What is a Roth IRA?

A Roth IRA is funded by money that you've already paid taxes on—also known as after-tax dollars—so withdrawals are tax-free. While there is no tax deduction for Roth IRAs, your investments grow deferred in the account, and you don't pay income taxes on qualified withdrawals.1

You can invest the money in a Roth account in a variety of assets, including stocks, bonds, mutual funds and exchange-traded funds (ETFs).

Who is eligible to open a Roth IRA?

Anyone who has earned income (according to the IRS definition) can contribute to an IRA. Earned income is money from a job or self-employment. Income that doesn't qualify as earned includes rental income, capital gains, IRA distributions, Social Security retirement benefits, interest and dividends.

Unlike traditional IRAs, Roth IRAs have income limitations:

Filing status
2023 maximum modified adjusted gross income to contribute to a Roth IRA2
Single or Head of Household
153,000
Married Filing Jointly
228,000
Married Filing Separately
$10,000

How does a Roth IRA work?

Roth IRAs work similarly to other retirement plans. You make contributions and, when eligible, you take distributions to fund retirement or other qualified needs.

How IRA contributions work

  • 2023 contribution limits: $6,500 under age 50; $7,500 age 50 or older

There are several ways to fund a Roth IRA including regular contributions, Roth conversions and rollover contributions.

Regular contributions

You can open an IRA account by working with a financial services firm. You can contribute directly. The deadline to contribute to a Roth IRA is typically April 15 of the following tax year. For the 2022 tax year, you must make contributions by April 18, 2023. (If April 15 falls on a weekend or holiday, the deadline typically shifts to the following business day.)

Roth conversions

One way to fund a Roth IRA is to convert a traditional IRA into a Roth.3 You can perform a Roth conversion regardless of how much you earn. When you convert a traditional IRA into a Roth, you're taxed as if you received a distribution.

You can minimize this tax hit in a few ways. For example, you might perform a Roth conversion in a year in which you have a dip in income and are therefore in a lower tax bracket. You also can spread your conversion out over a few years instead of getting hit with the tax bill all at once.

Deciding whether to convert your traditional IRA into a Roth—and planning for the tax bill—is complex. For this reason, it's a good idea to discuss the possibility with your financial advisor and tax professional.

> Read more about the pros and cons of Roth conversions.

Rollover contributions

You also can roll over funds from an employer-sponsored retirement plan, such as a 401(k), into a Roth IRA.4

If the plan allows for Roth 401(k) contributions, you can roll these amounts directly into a Roth IRA. Otherwise, you can convert non-Roth funds into a Roth IRA and pay taxes on the conversion just as you would when converting a traditional IRA into a Roth.

Roth IRA vs. Traditional IRA: What's the difference?

Now that you understand the basics of a Roth IRA, here's a quick look at the differences between traditional and Roth IRAs:

 
Roth IRA
Traditional IRA
Contributions
Made with after-tax dollars (not tax-deductible)
Made with pretax dollars (may be tax-deductible)
Growth
Tax-deferred
Tax-deferred
Withdrawals
Penalty and tax-free after 5 years and age 59½
Penalty-free but taxed as ordinary income after age 59½
RMDs
No
Yes, after age 72
Income Limits
Yes
No

 > Learn more about the differences between traditional and Roth IRAs.

How Roth IRA withdrawals work

Qualified withdrawals from a Roth IRA are the payments you can take after reaching age 59½ and meeting the five-year rule. These withdrawals aren't taxable, and you won't owe a penalty for taking the money out.

However, if you don't meet both requirements,1 you have a nonqualified distribution. In that case, taxes and penalties depend on whether you withdraw your original contributions or your contributions and earnings.

You can withdraw your original contributions to a Roth IRA tax-free and penalty-free at any time. But you'll owe income taxes if you withdraw any earnings from the account within five years of making your first contribution and before turning 59½. You also will owe a 10% early withdrawal penalty if you don’t meet one of the IRS penalty exceptions.

Once you've had the account for five years and turn 59½, you can withdraw both earnings and contributions from your Roth IRA for any reason without paying income taxes or penalties.

Thankfully, there are a few exceptions to the Roth early withdrawal penalty rules. This makes it possible to withdraw money during times of need, when your options may be limited. You may be able to avoid penalties (but not taxes) if you use the money to:

  • Purchase your first home (up to $10,000)
  • Pay for qualified education expenses
  • Pay for qualified expenses related to the birth or adoption of a child
  • Cover expenses after you become disabled
  • Pay for out-of-pocket medical expenses or health insurance while you're unemployed

You can find more information on these exceptions in IRS Publication 590-B.

Do Roth IRAs have required minimum distributions (RMDs)?

No, RMD rules don't apply to Roth IRAs. So, if you don't need the money for living expenses in retirement, you can leave it in your account indefinitely. However, your beneficiary will be subject to withdrawal requirements.

Is a Roth IRA right for you?

When considering a Roth IRA, think about your current earnings. It's impossible to predict the future, but if you expect tax rates to increase or anticipate being in a higher tax bracket when you retire, contributing to a Roth IRA might be right for you. This can allow you to pay taxes on the money used to fund your Roth now at the current rates, and then enjoy tax-free income in retirement.

On the other hand, if you expect tax rates to decrease or believe you may be in a lower tax bracket when you retire, a traditional IRA might be the option to consider. Traditional IRA contributions allow you to benefit from tax-deductible contributions now and pay taxes at a lower rate in retirement.

While deciding what's right for you can seem complex, it's important to remember that a Roth IRA is ultimately meant to provide support during your golden years. You work hard so that you can enjoy carefree years after leaving your profession. Figuring out the best ways to manage this retirement account can greatly benefit you as well as your heirs.

If you're interested in learning more about the benefits of a Roth IRA or converting an existing retirement account into a Roth account, connect with a local Thrivent financial advisor. They can help you learn more about the nuances of saving for retirement and how a Roth IRA may complement your plan.

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1Distributions of earnings are tax-free as long as your Roth IRA is at least five years old and one of the following requirements is met: (1) you are at least age 59½; (2) you are disabled; (3) you are purchasing your first home ($10,000 lifetime maximum); or (4) the money is being paid to a beneficiary.

2If you are an active participant in an employer-sponsored retirement plan for 2023 your contribution deduction is reduced if MAGI is between $138,000-$153,000 on a single return and $218,000-$228,000 on a joint return. If you're married filing jointly and an active participant in an employer-sponsored retirement plan and your spouse is not, the deduction for your spouse's contribution is phased out if MAGI is between $218,000-$228,000. If you're a married taxpayer who files separately, consult your tax advisor.

3State tax rules may differ from federal rules governing the tax treatment of Roth IRAs, and there may be conflicts between federal and state tax treatment of IRA conversions. Consult your tax professional for your state's tax rules.

4There may be benefits to leaving your account in your employer plan if allowed: You will continue to benefit from tax deferral; there may be investment options unique to your plan; fees and expenses may be lower; plan assets have unlimited protection from creditors under federal law; there is a possibility for loans; and distributions are penalty-free if you terminate service at age 55+. Consult your tax professional prior to requesting a rollover from your employer plan.

Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

Thrivent financial advisors and professionals have general knowledge of the Social Security tenets. For complete details on your situation, contact the Social Security Administration.
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