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  • Writer's pictureRegina Bedolla

What is a Roth IRA and how does it work?

A Roth IRA is an individual retirement account (IRA) that allows you to contribute after-tax dollars and withdraw them at retirement tax-free. The Roth IRA is a great savings tool if you are in a low tax bracket now and expect to be in a higher bracket in the future.

Who is eligible to contribute to a Roth IRA?

In order to be eligible to contribute to a Roth IRA, you must meet the following criteria:

- Have earned income (typically compensation from employment or self-employment).

- No age restriction.

- Income limitations do apply, see below.

How much can I contribute to a Roth IRA?

You can contribute up to the lesser of 1) $6,000 or 2) earned income.

If you are age 50 or older at the end of the year, you can contribute the lesser of 1) $7,000 or 2) earned income.

What are Roth IRA income limits?

Unfortunately, there is an income limitation surrounding Roth IRA contributions. One of the final eligibility criteria is based on modified adjusted gross income (MAGI). MAGI refers to an individual's adjusted gross income (AGI) after taking into account certain allowable deductions and tax penalties.

Roth IRA contributions income phase-out ranges for 2022 are:

$129,000 to $144,000 - Single taxpayers and heads of household

$204,000 to $214,000- Married, filing jointly

$0 to $10,000 - Married, filing separately

If your MAGI falls below the phase-out range, you can contribute the full amount. If your MAGI falls within the phase-out range, you will be eligible to contribute a reduce amount. If your MAGI falls above the phase-out range, you are not eligible to contribute to a Roth IRA for 2022.

It may be possible to convert traditional IRA contributions into a Roth IRA to get around the income limitations; however, that topic is beyond the scope of this post.

When are Roth IRA contributions made?

Contributions must be made by the due date of the return, not including extensions. For 2022 contributions, this is April 17, 2023.

Can I have a 401(k) and a Roth IRA?

Yes; there is no impact on eligibility based on if you are covered by an employer retirement plan.

Do I get a tax break by contributing to a Roth IRA?

Roth IRA contributions are made of after-tax dollars. As such, there is no deduction available on your tax return for these contributions.

Taxpayers under a certain income threshold may qualify for the Saver’s Credit which offers a maximum credit of $1,000 dependent on filing status, MAGI, and the amount of the Roth IRA contributions.

Eligibility for the saver’s credit has income phase-out ranges for 2022 as follows:

$41,000 to $68,000 – Married, filing jointly.

$30,750 to $51,000 – Head of household.

$20,500 to $34,000 – Singles and married individuals filing separately.

How to withdraw contributions from a Roth IRA?

In order to withdraw funds tax-free, you must:

Have held the Roth IRA for a minimum five-year holding period which begins on the first day of the first year for which Roth IRA contributions were made and have one of the following apply:

· Be at least 59 ½ years old.

· Have the distribution be due to death or disability.

· Have the distribution be eligible for the first-time homebuyer exception to the 10% penalty tax on early distributions.

Withdrawals from a Roth IRA are considered to come first from your contributions to the account and then from your earnings. No income tax or 10% penalty will apply until total withdrawals exceed total contributions.

This post may not contain a complete analysis of the tax issues discussed herein and does not represent official conclusions or advice regarding the matter.

The information in this post is relevant for the 2022 tax year and may not be updated for future tax years.

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