Roth IRAs Can Be a Great Planning Strategy: The Basics

This is part one of a two-part series on Roth IRAs. This first part will look at the basics of Roth IRAs. The second part will look at more advanced planning strategies.

An Individual Retirement Account (IRA) is a savings vehicle in which an amount can be deducted from a contribution (with restrictions). The maximum contribution in 2021 is $6,000, and those 50 and older can contribute an additional $1,000. While the assets are in the IRA, the income is not taxable. However, when distributions are taken into retirement, those distributions are included in taxable income.

A Roth IRA is roughly the opposite of a traditional IRA. A taxpayer who contributes to a Roth IRA does not receive a contribution deduction. Profits grow tax free. And when distributions appear, they are generally not taxable.

A taxpayer is only eligible to contribute to a Roth IRA if his or her taxable income is within certain limits. Married taxpayers who file a joint return may contribute the full amount if their income is less than $198,000 in 2021. There is a phased out so taxpayers cannot contribute anything if their income is $208,000 or more. For unmarried taxpayers, they can make a full Roth IRA contribution if their income is less than $125,000 in 2021. There is a phase out up to $140,000 and then the contribution is not allowed.

While the eligibility Input To a Roth IRA based on the taxpayer’s taxable income, anyone may turns up Their IRA to a Roth IRA. When they make a transfer, the amount of the traditional IRA account is subject to income tax.

Let’s look at a quick example: John has an annual income of $300,000. He was released until 2022 due to the pandemic. He has no income in 2021. He has a traditional IRA of $50,000. He can convert his traditional IRA into a Roth IRA and will pay taxes at relatively low rates because his income is lower in 2021.

If a taxpayer is ineligible to contribute to a Roth IRA, they may be able to contribute a traditional IRA (deductible or non-deductible) and then convert that IRA into a Roth IRA.

A key factor in transferring (or contributing) to a Roth IRA is whether the tax rate at the time of transfer (or contribution) will be lower than the expected tax rate at the time of distribution.

The next article in the series will examine other planning strategies with Roth IRAs.

Stephen C. Hartnett, JD, LLM
Education Manager
American Academy of Estate Planning Lawyers, Inc.
9444 Balboa Street, Suite 300
San Diego, CA 92123
Phone: (858) 453-2128

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