Tag Archives: Tax-Free Retirement Income

The Roth IRA is 20 Years Old

The Roth IRA is 20 years old.  Where does the time go?  Time sure does seem to fly when you are having fun.  It seems to go faster when you are dollar-cost-averaging and building wealth.

That is exactly what the Roth IRA has done over the past 20 years.  It has been a great wealth building tool for many individual investors.  Since it was created, I have been depositing money into my Roth IRA in the form of dollar-cost-averaging with almost every paycheck for the past 20 years.

The Roth IRA has come a long way in 20 years.  The Roth IRA is named after William Roth a Senator from the state of Delaware and was part of the Taxpayer Relief Act of 1997.  What makes the Roth IRA different from a Traditional IRA is that unlike the Traditional IRA, there are not any immediate tax deductions.  The Roth IRA is funded with after-tax earnings and when the money is withdrawn at retirement, it is tax-free.

When I first started investing, the Roth IRA was not available.  It did not become available until I was investing for about 1-year.  As soon as I learned about the Roth IRA, it sounded like a great wealth building tool.

When the Roth IRA was first introduced, the annual contribution limits were only $2,000 per year for an individual who qualified. From 1998 until 2001, the contribution limits were $2,000. The contributions limits have slowly been increasing over the past 20 years.  In 2002, people over 50 have been allowed to contribute more in the form of a catch-up contribution as they got closer to retirement age.  In 2018, individual under the age of 50 can contribute $5,500 per year and people who are over age 50 can contribute $6,500 per year.

There are income limits on who can take advantage of the Roth IRA.  Single filers who earn less than $120,000 qualify for a full contribution.  Single filers who earn between $120,000 and $135,000 are eligible for a partial contribution.  Joint filers who earn up to $189,000 can take advantage of the full contribution.  Joint filers who earn between $189,000 and $199,000 are eligible for a partial contribution.

Since my wife and I earn less than $189,000 we are able to better diversify out retirement tax strategy.  We contribute to our Traditional 403B accounts to reduce our annual taxable income. We also contribute to our Roth IRA accounts to have money that can be withdrawn tax-free later on in retirement.

What if you want to contribute to a Roth IRA account, but do not qualify.  For those folks, there is a Backdoor Roth IRA method that could be used to convert a traditional IRA into a Roth.  That approach is more complicated based on taxation.  It might be wise to check with a CPA before trying to implement this strategy.

Unlike a Traditional IRA or 401K, there are not any Required Minimum Distributions (RMDs) with a Roth IRA.  In a Traditional IRA account, the money has to start to be withdrawn at age 70 ½. That is not the case with a Roth IRA.  The money never has to be withdrawn.  It can remain in the Roth IRA and the money can keep growing.

Since the money never has to be withdrawn, it is recommended by many financial professionals to drawdown Roth IRA accounts last.  We have added that strategy to our retirement drawdown plan.  Based on our age and different types of investment accounts, we will be following a Buckets Approach to funding our retirement.

We will first drawdown our taxable accounts.  The second source of retirement income will come from our Traditional IRAs based on the RMD schedule.  If we live long enough, the last source that we plan on drawing down is our Roth IRA accounts.

There are many benefits with passing on a Roth IRA to a surviving spouse.  They are not forced to take RMDs. They can roll the inherited Roth IRA over into their own Roth IRA.  They can also continue to contribute to the Roth IRA with new earnings.  These benefits do not apply to someone who inherits a Roth IRA who is not the spouse.

Another benefit of a Roth IRA is that you can withdraw money from the account prior to being age 59 ½.  With a Traditional IRA, there is a penalty for early withdrawals.  The money that a person withdraws early is taxed as ordinary income.  There is also a 10% penalty unless it is considered a special circumstance.  With a Roth IRA, there are not any penalties if the money that is taken out is limited to contributions.

Over the past 20 years, the Roth IRA has become a very popular type of retirement account.  According to the Employee Benefit Research Institute, more than 29% of all individuals have a Roth IRA account.  That is an amazing statistic since so many Americans struggle with saving money for retirement.

There are few things in life that most people agree on.  In the world of personal finance, I cannot think of anyone in the financial independence community who does not like the benefits of investing in a Roth IRA account.  It is hard to not see and embrace the ability to build wealth in an account that allows people to have tax-free income at retirement.

Do you invest in a Roth IRA account?

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