Time is your greatest asset when you invest with a Roth IRA. The earlier you begin investing, the greater your dividends will be during your retirement years. So, it is easy to understand why you would want to take advantage of accounts that let you build your tax-free retirement funds. There are many reasons to max out your Roth IRA this year, not the least of which is the extension for your 2020 contributions.
The Advantages of Maxing Out Roth IRA
When it comes to starting your retirement fund, the Roth IRA is one of the best options available. When you fund a Roth IRA, you capitalize on an important tax break if you contribute your after-tax dollars now. While traditional IRAs give you immediate tax breaks on your tax return, a Roth IRA lets you make withdrawals tax-free after retirement. A Roth IRA also gives you more control over your money since you choose the amount to invest.
One attractive feature of the Roth IRA is that you can maintain it indefinitely. Since there are no Required Minimum Distributions (RMDs), you are not required to make withdraws once your reach a certain age.
Additionally, you can withdraw what you put in at any time. You only pay a penalty if you prematurely take out the earnings in your account. So, there is no need to pay taxes if you only withdraw what you put into it.
A Roth IRA is especially good for young savers who will likely be in higher tax brackets after retirement. Thanks to compounding interest, you get the most of your money when you max out your Roth IRA from an early age. Therefore, the sooner you start funding a Roth IRA, the more time you have to accumulate assets.
The Restrictions for a Roth IRA
These types of accounts have several restrictions on them because they have the greatest returns. These limits are put in place because Roth IRAs offer such a strong incentive to invest and take advantage of them. Here are some of the most important restrictions you should be aware of, but you can find a more comprehensive explanation here that outlines every detail of contribution rules.
Although you can contribute to your Roth IRA at any age, you must have earned income for the year. However, if your income exceeds the set limit, you are ineligible to make any contributions for the year. If you do qualify, you can only contribute a maximum of $6,000 annually. If your earned income is lower than the threshold, you can only match the amount made after taxes.
There are no minimum contributions required, but you cannot exceed the yearly maximum threshold. The only exception to this rule is for people over 50 who can make a catch up contribution totaling $7,000. Keep in mind though, you can only make your annual contribution up until the tax filing deadline.
When it comes time to make withdrawals, there are no penalties for the sum you have put in. However, you cannot make withdrawals on any earnings the account has generated for at least five years. There is a 10% penalty if you withdraw the earnings within the first five years of opening and funding the account.
To start receiving distributions from your Roth IRA tax and penalty free, you must meet one of the following conditions:
- You must be at least 59 1/2 years old.
- The distribution will be used to help purchase, build, or rebuild the first home for an account holder or qualified family member.
- The account holder becomes disabled.
- The assets are being distributed to beneficiaries after the account holder’s death.
My Contributions for 2020
With a Roth IRA, you are investing in higher-quality assets so you earn even more tax-free income. So, it makes sense to max out these accounts first. Especially now, when you have an extra month to get your contributions for an extra month thank to the extended tax filing deadline.
When I returned to the U.S. last year, I began investing by setting up my first retirement account with a Roth IRA. Unfortunately, I fall under a weird caveat of restrictions placed on foreign earned income. Although I had been working in country for a few months of the 2020 fiscal year, I am only able to match watch I earned domestically. This amount was less than limits set for maxing out a Roth IRA, so I will not be able to make a full contribution for 2020. However, it will give me a good head start for 2021.
5 Reasons to Max Out You Roth Contribution This Year
Any financial advisor can provide a long list of reason why it is a good idea to begin investing sooner rather than later. However, here are five great reasons you should max out your Roth IRA contributions for 2020 as well.
1. The IRS extended the tax filing deadline this year.
Now is the best time of all for maxing out your Roth IRA contribution. This year, you have an extra month for 2020 contribution thanks to the filing extension deadline until May 17.
2. You can begin accruing tax-free income for retirement now.
Retirement may not be on your mind if you are just starting your career, but it is never too early to begin investing in your future. Every dollar you contribute today equates to more tax-free income available to you in your golden years.
3. With time on your side, compounding interest is reason enough to open a Roth IRA.
Since you are unable to easily access the earnings from a Roth IRA, it encourages the account holder not to make withdrawals. If the principle amount remains untouched, compounding interest will drastically increase your initial investment. If you have time on your side, compounding interest is your best friend.
4. You never know when circumstance will change.
At some point in your future, you may not qualify for Roth IRA contributions. So, it is wise to take advantage of opportunities when they present themselves.
5. A Roth IRA protects against increased taxation rates.
Taxes are most people’s biggest expense after retirement. Therefore, maxing out your Roth IRA means you keep more of your money since withdrawals are tax free.
Furthermore, if you add more money now, a Roth IRA protects you against increased taxation rate. Other retirement accounts like 401(k) and traditional IRAs will be heavily taxed when you withdraw. However, the money you add to your Roth IRA would be unaffected by any future rise in taxation rates.
As you can see, there are several good reasons to max out your Roth IRA this year. Contact your financial advisor with and specific questions about how to set up and take advantage of these retirement accounts.
- The IRS Extends the Tax Deadline for 2021
- Practical Ways to Make Use of Your Roth IRA
- 2020 Roth IRA Contribution Limits
Jenny Smedra is an avid world traveler, ESL teacher, former archaeologist, and freelance writer. Choosing a life abroad had strengthened her commitment to finding ways to bring people together across language and cultural barriers. While most of her time is dedicated to either working with children, she also enjoys good friends, good food, and new adventures.