You’ve probably heard by now that Roth IRAs have magical money-growing powers. OK, maybe they’re not quite magic.
But there’s a lot to love about Roth IRAs: The tax-free growth. The flexibility to access your contributions in an emergency. The fact that once you reach age 59 ½, you get to withdraw your money on your schedule — not one that’s made up by the IRS.
But while we could sing the praises of Roth IRAs all day long, let’s be real: Whenever the IRS gives us tax breaks and flexibility, it sets up a lot of rules.
So let’s talk about the Roth IRA rules you need to know.
What’s a Roth IRA? A Quick Introduction
A Roth IRA is a type of individual retirement arrangement. Like a traditional IRA, a Roth IRA is a retirement account that you set up for yourself to invest and save. Unlike a 401(k), an IRA isn’t connected to your job.
Here’s the most important thing you need to know about Roth IRAs vs. traditional IRAs: With a Roth IRA, you pay taxes now. As you continue to contribute (ideally to the max each year!), your money compounds. Then, when you reach retirement, that nest egg is all yours. You’ve already given the government its cut.
A traditional IRA reduces your taxable income now. But your taxes come due when you start withdrawing your money.
For a long time, 401(k)s were like traditional IRAs in that you got the tax break up front but paid taxes in retirement. But a growing number of employers are jumping on the Roth bandwagon and offering a Roth 401(k).
10 Roth IRA Rules to Know About in 2021
Now that you know the Roth IRA basics, you’re ready for a rundown of the Roth IRA rules.
The IRS updates the Roth IRA limits on income and contributions for inflation each year. Beyond that, the rules don’t change much.
1. You Can Contribute Up to $6K if You’re Under 50
The maximum contribution for both Roth and traditional IRAs in 2021 is $6,000 if you’re under 50. (Sound familiar? That’s because it’s the same rule as it was in 2019 and 2020.) You can have both a Roth IRA and a traditional IRA, but your total contributions between the two accounts can’t exceed $6,000.
2. Over 50? You Get an Extra $1,000 Contribution
The IRS allows taxpayers 50 and older to make an IRA catch-up contribution. In 2021, the rule for that amount remains at $1,000.
3. You Can’t Contribute if Your Income Is Above These Limits
Anyone with taxable income can contribute to a traditional IRA, but you can’t contribute to a Roth IRA if your earnings are above a certain threshold. (There’s a way around the income caps, but we’ll get to that shortly.)
The IRS adjusted the 2021 income limits for inflation, meaning you can earn slightly more than you did in 2019 or 2020 and still qualify for a Roth IRA. Here are the 2021 income limits.
2021 Roth IRA Income Limits
|Tax filing status||2021 Income||Maximum contribution|
|Single, head of household or married filing separately||Under $125,000||$6,000 ($7,000 if 50 or older)|
|Over $140,000||Not eligible|
|Married filing jointly or qualifying widow(er)||Under $198,000||$6,000 for each individual ($7,000 if 50 or older)|
|Over $208,000||Not eligible|
|Married filing separately (lived with spouse at some point in tax year)||Under $10,000||Reduced amount|
|$10,000 or higher||Not eligible|
4. … but You Can Get Around Income Limits With a Backdoor Roth IRA
If you earn too much to directly fund a Roth IRA, you can open what’s known as a backdoor Roth IRA. You fund a traditional IRA, then convert it to a Roth IRA.
You’ll owe taxes on the amount converted (remember, you haven’t paid taxes yet on those traditional IRA dollars), along with taxes on any gains from investments in your traditional IRA.
Opening a backdoor Roth IRA is complicated and can have serious tax consequences, so we’d always advise consulting with a tax professional and financial planner first.
If you have a 401(k), you can also lower your taxable income by increasing your contributions. The 2021 limits are $19,500 if you’re under 50, or $26,000 if you’re 50 or older.
5. There’s a Penalty for Contributing Too Much
If you contribute more than the Roth IRA rules allow, you’ll pay a 6% penalty every year that extra money remains in your account.
6. You Can Access Your Contributions at Any Time
Since you’ve already been taxed on your Roth IRA contributions, that money is yours at any time. That means you can access your contributions in an emergency, though we recommend building an emergency fund separately so you can let that Roth IRA keep growing fatter.
7. You’ll Be Penalized if You Touch Your Earnings Early Before Age 59 1/2
You’ll typically owe income taxes plus a 10% penalty if you withdraw Roth IRA earnings (but not your contributions) before you’re age 59 ½.
Then there’s the Five-Year Rule: You need to have had your account open for at least five years before you can withdraw your earnings without paying taxes and the 10% penalty.
If you’re withdrawing money from a Roth IRA, your contributions will always be taken out before your earnings.
8. But Wait! There Are Exceptions
If you’ve had the account for at least five years, there are some times you might be able to withdraw your earnings before age 59-1/2 without penalty or taxes.
- You become unemployed and use the money for health insurance premiums.
- You become disabled or die.
- You can withdraw up to $10,000 of your Roth IRA earnings for a first-time home purchase. (Even if you’ve owned a home, the IRS will consider you a first-time buyer if you haven’t owned a home in the last two years.)
You’ll pay income taxes but avoid the 10% early withdrawal penalty under the following circumstances. However, you still must have had the account for at least five years.
- Medical expenses that exceed 10% of your adjusted gross income.
- Higher education expenses for yourself or a dependent.
- Pay for health insurance premiums if you are unemployed.
9. You Can Contribute Forever if You Have Taxable Income
With a traditional IRA, your contributions have to stop when you reach age 72. But with a Roth IRA, you can keep those contributions coming, so long as you have taxable income, like a salary, hourly wages, bonuses or tips.
10. You Never Have to Withdraw Your Own Money
Traditional IRAs and 401(k)s require you to start withdrawing your money when you’re 72 by taking what’s known in tax speak as a required minimum distribution, or RMD. (One exception: In 2020, no one has to take an RMD due to the CARES Act retirement rules.)
But with a Roth IRA, you never have to withdraw money. You can keep saving your money, or you can pass it on to your heirs tax-free when you die. If you leave your Roth IRA to your spouse, they can either delay distributions until you would have reached 72, or claim the account as their own and face no RMDs during their lifetime. If you leave it to someone else, they’ll eventually have to take distributions.
Ready, Set, Go Fund Your Roth IRA
If you’re ready to take full advantage of that Roth IRA magic, you may have more time than you think.
The deadline for funding a Roth IRA for any calendar year is tax day of the following year. So you can keep working to max out your 2020 contribution until April 15, 2021.
Cheers to funding your future in 2021 and beyond.
Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected]