How to Reduce Your Lifetime Tax Bill With a Roth IRA - WTOP News (2024)

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It’s safe to say that pretty much everyone wants to slim down their tax bill. Investing in a Roth individual retirement account is one way to decrease your taxes.

A Roth IRA is a tax-advantaged retirement account. Unlike a traditional IRA, where you don’t pay taxes on the money contributed until you take a distribution, contributions to Roths are made with after-tax dollars.

That means a Roth IRA’s qualified withdrawals, including earnings, are tax-free, making it a valuable tool for people who want tax-free income during retirement.

Tax-free income helps retirees maximize their spending power and maintain their lifestyle with a lower tax burden.

[See: 10 Reasons to Save for Retirement in a Roth IRA.]

How Do Roth IRAs Offer Tax Savings?

Roth IRAs help investors save money on taxes by allowing contributions with after-tax dollars and offering tax-free withdrawals on qualified distributions. Taxes can be among retirees’ largest expenses, so that’s a significant advantage.

“Roth IRAs offer the most tax savings when people are in a lower tax bracket when they contribute than when they take the money out,” said Kathryn Kubiak-Rizzone, a certified financial planner at About Time Financial Planning in Rochester, New York, in an email.

“You make contributions with after-tax money, but because the investments grow and can be withdrawn completely tax-free, there can be opportunities to save big time in future years,” she added.

Many retirees find that they’ve accumulated a large balance in a traditional 401(k) or IRA, resulting in large tax bills due to required minimum distributions from those accounts.

Kubiak-Rizzone said those large RMDs could even push retirees into a higher tax bracket, possibly resulting in higher Medicare premiums.

“Roth IRAs have no RMDs, which is great because you can strategically pull money out in ways that make the most tax sense,” she said.

What Are the Contribution Limits for Roth IRAs?

The Roth IRA contribution limit for 2023 is $6,500 for investors under 50 and $7,500 for those 50 and older. You have until April 15, 2024, to make your 2023 Roth IRA contribution.

Those limits go up for tax year 2024, with the Roth IRA contribution limit set at $7,000 for those under 50 and $8,000 for investors 50 and older.

“And remember, these numbers tend to get a little bump from the IRS occasionally, so keep an eye out,” said Joe Petry, certified financial planner and founder of Mayfair Financial in St. Louis, in an email.

Use caution if you plan to contribute to both a traditional and Roth IRA. The IRA contribution limits are combined for the two types of accounts.

For example, if you’re 40 years old and planning to contribute $3,500 to your traditional IRA for tax year 2023, you’re limited to a $3,000 contribution to a Roth IRA. If you go over that combined limit, you may incur penalties.

Who Is Eligible to Invest in a Roth IRA?

Investors with earned income within specific limits are eligible to contribute to a Roth IRA.

“Your modified adjusted gross income determines whether you can contribute the full amount, a reduced amount or nothing at all,” Petry said.

He added that additional criteria include your tax-filing status and whether your household has earned income.

Single taxpayers with modified adjusted gross income, or MAGI, of less than $138,000 are eligible to contribute the full amount of $6,500 to Roth and traditional IRAs for tax year 2023. A catch-up contribution for those 50 and older increases the contribution amount to $7,500. Single filers with MAGI between $138,000 and $153,000 are eligible to make a partial contribution.

Married taxpayers filing jointly with household income less than $218,000 may contribute $6,500 to each spouse’s IRAs for tax year 2023. Catch-up contributions increase the limit by $1,000 for savers 50 and older.

For tax year 2024, the income threshold for a single person rises to $146,000. The 2024 contribution limit is $7,000 for those under 50 and $8,000 for those 50 and over. The 2024 income limit for married couples filing jointly rises to $230,000 to be eligible to make full Roth contributions of $7,000 for those under 50 and $8,000 for those 50 and over.

Remember: You can’t contribute more to a Roth IRA than your total earned household income.

[READ: Are You Too Old to Benefit From a Roth IRA?]

Are the Penalties for a Roth IRA Early Withdrawal the Same as for a Traditional IRA?

One feature many investors like about Roth IRAs is that there are no required minimum distributions at age 73, as is the case with traditional IRAs.

However, Roth IRA withdrawals cannot be taken before age 59 1/2 without a penalty. That’s the same as with a traditional IRA.

Investors who make a Roth withdrawal before the end of a five-year holding period are subject to taxes on their earnings. That takes away one of the Roth’s key benefits: tax-free withdrawals.

“Roth accounts are also great for legacy planning purposes,” said Theresa Cagle Fry, senior vice president and manager of IRAs and retirement and education planning at Benjamin F. Edwards in St. Louis, in an email.

Fry explained that most nonspouse beneficiaries are required to withdraw retirement account assets they inherit within 10 years. That means someone inheriting a large traditional IRA or 401(k) could face substantial tax consequences.

“Inheriting a Roth IRA, on the other hand, would allow the beneficiary to not only take whatever amounts they want during those 10 years, but if they left the entire inherited Roth IRA alone until year 10, they would make the most of the tax-free earnings that the Roth IRA provides,” Fry said.

[See: 12 Ways to Avoid the IRA Early Withdrawal Penalty.]

Benefits of the Roth Having No Withdrawal Requirements

Other than the rules for inherited IRAs, there are no Roth IRA withdrawal requirements from the Internal Revenue Service. In other words, if you open a Roth account, you can let the money grow throughout your lifetime without having to take distributions as you would with a traditional Roth.

“A Roth IRA with no withdrawal requirements is like having a financial genie in a lamp that grants you the freedom to choose when and how you access your wishes without any deadlines,” Petry said.

That benefits investors who want to pass along as much as possible to heirs. By simply letting the Roth balance grow over time, there will be more available as part of an estate plan.

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How to Reduce Your Lifetime Tax Bill With a Roth IRA originally appeared on usnews.com

Update 01/24/24: This story was published at an earlier date and has been updated with new information.