My Comments: The recently enacted SECURE Act did not fundamentally change the set of rules about accumulating money for retirement. But it did change the landscape for many people.
For years, the Roth IRA has seemed like an exotic step-child in the financial planning world. I think this happened because contributions to Roth IRAs generally only happen if you’re willing to first pay income taxes on the money earned. There are no up-front tax benefits.
For years, the financial planning community has focused on tax-deferral strategies. The discussion with clients has always been about ways to minimize, if not eliminate, earned income taxes.
The benefits of a traditional tax-deferred account are no up-front taxes and no taxes along the way until a withdrawal takes place. If you’re then in a lower tax bracket, so much the better.
The obvious benefit of a Roth IRA is that withdrawals after age 59½ are not taxable as ordinary income. In the meantime, the money grows tax free and if it’s been there a long time, there’s a chance it’s now a significant pool of money from which to withdraw tax-free retirement income.
The new rules have changed the landscape for traditional retirement accounts in terms of what happens to positive account values when you die. That money must now be completely distributed to named beneficiaries by the end of ten years following the death of the owner participant. The legacy possibilities are now limited compared to what they were before.
An exception to this, so far, is money left over in a Roth IRA. Since taxes were paid on the money going in, the powers that be decided that was the only tax that need be collected. They also gave the account owner the ability to extend the time limit to the lifetime of the named beneficiaries.
Here are several things you should know about Roth IRAs to help you make an informed decision about them and whether they are a real option for you.
By Jeff Rose \ 21 JAN 2020 \ https://tinyurl.com/wh6rn4y
Understanding all the Roth IRA rules may seem difficult, but if you plan on adding to your Roth IRA as a part of your portfolio in order to secure a stable and enjoyable retirement, it makes sense to have all of the current information regarding the current IRS regulations concerning the Roth.
Plus, you want to have a grasp of the current IRA rules for any given year. And with the new year, many people are already planning their retirement contributions and looking forward to what 2020 might bring.
If you made the maximum contribution amount into your Roth for 2020 and are thinking about saving for next year’s contribution, you may also want to know what the new limits are – as well as the new income caps.
Or maybe you’ve just got your eye on the tax season. No matter what, you should be well aware of all of the latest details before you start making decisions about your IRA. Fortunately, we have all the answers in a single article – and you just happen to be reading it.
2020 Roth IRA Rules You Should Be Aware Of
As to be expected, there are some differences in the Roth IRA rules for 2020 that help this type of account stand out from previous years.
Late last year, the IRS revealed its current Roth IRA rules for 2020. This data was based on a variety of factors and figures and includes inflation statistics they used to come up with new limits for contributions.
1. Contribution Limits are Unchanged for 2020
Standard Roth IRA contribution limits remain the same from last year, with $6000 being the limit any individual can contribute. In addition, plan participants ages 50 and over have a limit of $7,000, which is commonly referred to as the “catch up contribution.” You can also contribute to your ira up until tax day of the following year.
2. Roth IRA Phase-out Limits Have Increased
The AGI phase-out range for taxpayers making contributions to their Roths has increased for 2020, is now between $196,000 and $206,000 for couples who file jointly. A similar increase took place for singles who file taxes and contribute to a Roth IRA. As of 2019, the range where phase-outs begin now starts at $124,000 and ends at $139,000. Meanwhile, married individuals who file separately and have been actively participating in an employer-sponsored retirement plan should see no changes in the phase-out range.
3. Direct 401k Rollovers Into Roth IRA’s is S-I-M-P-L-E
Another rule that remained the same but still offers more opportunity than was available prior to 2010 concerns direct rollovers for 401(k) to a Roth IRA.
The process used to require you to open a traditional IRA account, then roll over your 401(k) into it and end by opening a Roth account and converting the traditional IRA into a Roth.
In 2010, this changed by skipping a step, letting you convert it directly from the 401(k) to a Roth IRA. It’s less of pain and there is certainly less unnecessary paperwork.
4. Roth IRA Conversions Continue
In 2020, the rules are the same as in 2020. Whatever is converted in 2020 must be reported in 2020.
Want more information on the Roth IRA Conversion? You can see more on the conversion tax rules regarding after tax contributions.
5. IRA Recharacterization is Prohibited
If you initiated a Roth IRA conversion and then decide it wasn’t the best idea in previous years, you could do a “take back” in the form of a recharacterization. Due to the Tax Cuts and Jobs Act, you can no longer recharacterize Roth IRA conversions from SEP IRAs, SIMPLE IRAs, traditional IRAs, 401(k)s, and 403(b)s. If the conversion occurred after October 15, 2018, it cannot be recharacterized.
6. *NEWER RULE* Roth Conversions from Your Existing 401k
This new option was released a few years ago in the Small Business Tax bill. If you are still working, are at 59.5 in age, and your plan allows it, you can do what’s called an in-service distribution with your 401(k) into an IRA. Once you reach the IRA, you then, of course, can do the conversion. What you might not know is that some plans allow you to take out certain “parts” of your 401(k) balance.
The key here is “parts.” You still aren’t able to distribute your entire 401(k) balance and then do a conversion. Where the rules change a bit is regarding the employer profit sharing and employer contributions. These two type of contributions are available for the in-service distribution provided they meet these criteria:
- The money has been in there for at least 2 years.
- You, the employee, has been in the plan for at least 5 years; or you’ve reached an age that has been satisfied according to your plan documents.
In-service distributions are offered by the majority of employers, but they are not a requirement. Check with your employer or plan administrator on availability. Also, be aware that these distributions are complicated, so be sure to consult with your tax advisor before you do anything.
Please note: If you have rolled over an IRA or old 401k into your current 401k or you have contributed after-tax contributions, those will be allowed for an in-service distribution. This is providing the plan document allows it.
7. If You Can’t Convert to Roth IRA…What About Roth 401k?
If you don’t qualify for the in-service distribution, you don’t have to throw in the towel quite yet. The IRS has released guidance about the possibility of converting your 401(k) to a Roth 401(k). However, in order to qualify or even entertain this option, you must have a Roth 401(k) option with your current plan.
In other words, no Roth 401(k) option = no conversion.
Another important consideration: Unlike the Roth IRA conversion, there is NOT an option to recharacterize with a conversion to a Roth 401(k).
The key to all this is dependent on your 401(k) plan, and unfortunately, they are all different. The best thing to do is to check with your HR department to see if any of these options are available.
Here’s another piece of advice: If your employer doesn’t offer it, stay on them and continue asking for the retirement perks you really want. A little bit of pressure and persistence never hurts, and they may end up adding the option if they see there is a demand.
Benefits people wanted this option to allow plans to retain assets that otherwise would be distributed out of the plans for Roth IRA conversions. Here is the IRS release on these conversions: https://www.irs.gov/pub/irs-drop/n-10-84.pdf.
Does it Apply to 403b’s?
(Note: a 403b is similar to a 401k but applies to not-for-profit employers like colleges, hospitals, cities and counties, etc.)
If you’ll look into the IRS publication, you will see that the in-service Roth IRA conversions can also apply to 403b’s. Once again: Double check with your plan administrator. Notice a theme here?
Benefits of a Roth IRA
Obviously, there are certain benefits that come with investing in your Roth with only after-tax dollars. For starters, being able to invest with after-tax dollars offers the distinct advantage of letting your money grow tax-free in this case. When you’re ready to take distributions at retirement age, you won’t have to worry about how the tax landscape has changed, or whether or not you’re at a lower or higher tax bracket than you were before.
Because of this, many financial professionals believe that having a Roth IRA is one of the best ways to diversify your tax liability. By having different types of accounts – including some that tax distributions and a Roth IRA, which does not – you can shield yourself from any unknown changes that could take place within our tax system.
With any type of retirement account, you’ll owe taxes now – or you’ll owe taxes later. Paying taxes on your money now and investing in a Roth IRA means you’ll pay up now, but manage to shield yourself from paying taxes on those funds in the future.
Since many people believe income taxes could be considerably higher in the future, this is often seen as a pretty sweet deal.
Lastly, you can withdraw your contributions to a Roth IRA without penalty at any time, which is why the Roth is also used a long-term savings vehicle for many people. Please note, however, that you can only withdraw contributions without penalty until the age of 59 ½. If you want to withdraw earnings, you’ll pay a 10% federal penalty tax.
The Roth IRA Saver’s Credit
While we know it’s beneficial to save, sometimes the additional money we lose from our wages to save for retirement can be a burden. The US Government implemented the saver’s credit back in 2002 as a way to encourage Americans to start saving more money for retirement. Since then the program has become permanent, and as of 2006 has remained available for those who qualify to claim on their income tax returns. Unlike tax deductions, tax credits can do more than just reduce the tax you owe, they can increase your refund. It is worth trying to see if you are eligible to claim this credit.
Not everyone is eligible to claim the saver’s credit. However, if you contribute to a retirement account like a Roth IRA and meet the other requirements you may be eligible to claim the saver’s credit. Students cannot claim the credit, nor can someone who is claimed as a dependent on another individual’s tax return. You must also be 18 years old or older in order to apply for the credit.
Being eligible for the credit is dependent on your adjusted gross income (AGI). Your AGI must be below the set limits in order to apply. Here are the limits for each filing status:
What is the Credit?
The saver’s credit is determined based on a percent of your total contribution to a retirement account. The maximum amount one is allowed to contribute to a Roth IRA is $6,000 annually. The saver’s credit is figured on the first $2,000 of that money or as much as you have contributed up to $2,000. Because the saver’s credit is based on the person’s adjusted gross income in conjunction with their filing status, the amount of the credit will vary for all filers.
Contributions made to military retirement accounts do not qualify for the credit. Also, you can not claim the credit on rollover distributions, nor can you claim the credit on contributions made to repay a previous distribution.
How to Claim It
In order to claim the saver’s credit for Roth IRA savings, you must complete form 8880. You must file form 1040 or 1010-SR in order to use Form 8880. This form is filed with your regular tax return and supports your deduction. Even if you did not make any contributions in the previous year, you can still claim the credit up to the April 15th tax deadline.
Disadvantages of Having a Roth IRA
Of course, not everyone likes the setup and structure of Roth IRA accounts. For starters, the low contribution limit of $6,000 for 2020 ($7,000 for individuals ages 50 and over) isn’t nearly enough to make or break your retirement. That’s why most financial professionals suggest contributing to a Roth IRA only after (or in conjunction with) maxing out your tax-advantaged retirement accounts.
Second, the income caps that government enacts on Roth IRAs severely limit the number of people who can make the full contribution. Third, some people approach Roth IRAs with feelings of trepidation due to a general distrust of the government. Just because you are promised tax-free distributions twenty, thirty, or even forty years from now, doesn’t mean the economy won’t change so much that the rules are forced to change.
Hopefully that won’t happen and Roth IRA distributions will remain tax-free for the long haul, but many investors fear the worst. After all, thirty years from now is practically a lifetime away.
6 Reasons to Get a Roth IRA
Although Roth IRAs are far from perfect, no retirement savings vehicle offers terms that everyone will love. In the real world, there are plenty of reasons a Roth IRA could be the perfect addition to your long-term savings and retirement strategy. Here are 6 times when a Roth IRA makes perfect sense:
1. You think you’ll be in a higher tax bracket when you retire.
If you think you’ll be in a higher tax bracket when you retire or have reason to believe taxes will be higher across the board, contributing to a Roth IRA now might be a tax-savvy move. By contributing with after-tax dollars that were charged a lower tax rate now, you can save money by not paying taxes on your distributions later. At least in theory, this is how it is supposed to work.
2. You want to diversify your exposure to taxes.
If you’re contributing to tax-advantaged retirement accounts in addition to a Roth IRA, you’re in the best position to diversify your exposure to taxes – both now, and in the future. All of us will pay now, or we’ll pay later, but by having traditional retirement accounts and a Roth, you’ll experience a little bit of both.
3. You’re already maxing out your work-sponsored retirement accounts.
If you’re maxing out your tax-advantaged retirement accounts and still want to save more for retirement, a Roth IRA might be a smart bet. After all, it just gives you another place to stash away your retirement dollars – and the money you invest could grow considerably over time.
4. You want to invest for retirement, but think you might need to get your money out one day.
Since you can deduct your contributions from a Roth IRA at any time without penalty, a lot of people use them as a form of long-term savings. They may not think they’ll need to access that money, but they want to leave the door open to the option.
A Roth IRA is a smart place to invest your money if you know that you may need it before retirement.
However, it’s important to note that a Roth IRA will inevitably have more risk than other long-term savings vehicles like Certificates of Deposit (CDs) or savings accounts. With a Roth IRA, you can actually lose money.
5. You want flexibility in terms of when you take withdrawals.
Where 401(k) plans and traditional IRAs force you to begin taking withdrawals at age 70 1/2 at risk of paying a large penalty if you don’t comply, the Roth IRA has no such requirement. Therefore, this type of account is a great option for anyone who doesn’t want the hassle of forced distributions when they get old enough.
6. A Roth IRA is a solid estate-planning tool – at least when it comes to taxes.
If you don’t think you’ll need every penny of your retirement funds, a Roth IRA is a great place to stash away your extra dollars. Since distributions are generally tax-free, you can usually leave your account to your heirs, which will allow them to take tax-free distributions.
With your tax-advantaged retirement accounts, on the other hand, your heirs will need to pay income taxes on your retirement funds as they withdraw them.
The Bottom Line
If you think a Roth IRA might be in your future, don’t delay. Get started now by choosing one of the above accounts to get started with. Not sure which account you want? Our posts on the best places to open Roth IRA and the best online stock brokers can help you figure out which broker will work best for your retirement goals, and your personal investing style.