By Charles Thomas, MBA

Roth IRAs are still a fairly new type of retirement account that have benefits that go unused by many. Roth IRAs can play an important role in long-term financial planning, especially for younger generations.

Eligibility

There is no age limit on when people can open and contribute to a Roth IRA. They just need earned income. If you have a babysitting job at the age of 15 and make $2,500, you can contribute $2,500 for the year.

Contribution Limits

In 2022, an individual can contribute up to $6,000. If they are over age 50, they are allowed a “catch-up” of $1,000.

If the individual makes over $144,000 or a married couple earns over $214,000, then no Roth IRA contributions are allowed for that year.

Withdrawal Exceptions

A concern we often hear is that younger people need access to funds for college, a first home purchase, a wedding, their firstborn, etc. There are exceptions that make a Roth IRA a valuable option:

• A person can remove Roth IRA contributions at any time for any reason (but may have to pay taxes and penalties on withdrawal of earnings).

• First-time home buyers can remove up to $10,000 from their Roth IRA. If the account has been open for five years or more, they can remove earnings penalty-free.

• Each parent is allowed to take $5,000 in the first 12 months after having or adopting a child. (This is one of the few exceptions allowing an individual to put the money back in.)

• An individual may use funds from a Roth IRA to pay for higher-education expenses. They will avoid the 10% penalty but may still have income tax on the earnings.

Cash Flows

Often, younger people do not have the extra cash to fund a Roth IRA. One way to contribute is via leftover money in a college savings account, like a 529 plan.

Depending on the account, there may be a penalty incurred. But younger people in lower tax brackets may find it worthwhile to take the penalty now instead of waiting until they are in a higher bracket or no longer eligible to contribute to a Roth IRA.

Tax Advantages

Many tax advantages are often overlooked when it comes to Roth IRAs. The tax benefits are:

• The Roth IRA grows tax-free, so you do not have to pay income tax or capital gains tax during retirement.

• Most younger people make less than the salary limit, which allows them to contribute before they start earning more and can no longer contribute. Even then, the funds still grow tax-free until their retirement.

• With Roth IRAs, there is no required minimum distribution (RMD) at age 72 like traditional IRAs have.

Tax Disadvantages

The one disadvantage compared to other retirement accounts is an individual does not get the tax deduction they would get for their contributions to a traditional IRA or traditional 401(k).

Roth 401(k) vs. Roth IRAs

A question we hear a lot is “Can we contribute to both a Roth 401(k) and Roth IRA?” Yes, you absolutely can.

The limit for the Roth 401(k) is $20,500 (2022), and after the age of 50, there is a catch-up of $6,500. The Roth 401(k) may be limited in investment options but still grows tax-free. Roth 401(k)s do have an RMD requirement beginning at age 72, but an individual can roll a Roth 401(k) into a Roth IRA to avoid the RMD.

A common misconception is an employer match will go to a Roth 401(k). An employer can only put a matching contribution into a traditional 401(k). You will still get the match for your contributions to your Roth 401(k), but the match will go into a separate traditional 401(k) account.

From a planning perspective, this allows the individual to have multiple buckets to choose from during retirement to minimize their taxes.

Conclusion

Roth IRAs can be especially beneficial for younger generations who can contribute to a Roth IRA and let their investments grow tax-free until they retire or need it to begin their careers.

DISCLOSURE

The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Northstar to be reliable, and Northstar has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations.