A Roth Individual Retirement Account (IRA) is one of the most powerful ways you can invest for your retirement. Once your money is legally in that type of account, it can potentially grow tax-free for the rest of your life.
Unlike other retirement accounts, you aren’t required to withdraw money from your own Roth IRA within your lifetime. If you reach age 59 1/2 and have had a Roth IRA funded for at least five years, you can withdraw up to the entire value of your account and owe absolutely no taxes on that withdrawal .
That combination makes it so that as a general rule, if you can fund a Roth IRA, you should fund a Roth IRA. If there’s a serious drawback to Roth IRAs, though, it’s that you can only sock away up to $6,000 a year into one ($7,000 if you’re age 50 or up). That annual limit means that if you want to build up a decent balance, you should contribute to one whenever you can. Fortunately, if you’re eligible, you can still fund your Roth IRA for 2021.
In fact, you have until April 15, 2022
The contribution deadline for your 2021 Roth IRA is April 15, 2022. Your money must be in your account by that date, otherwise you cannot consider it a 2021 contribution. This extra time gives you a great window to take advantage of the market’s recent downswing by seeking out opportunities made available by that downturn.
Of course, the real reason the deadline is set in April has nothing to do with the market’s recent performance. It’s more because there are income limits to your eligibility to contribute to a Roth IRA. Letting you contribute up until the tax filing and payment deadline for the year lets you understand if you’re eligible to contribute before you inadvertently sock away your hard-earned money illegally.
After all, there’s a 6% penalty for over-contributing to your Roth IRA — and that penalty continues every year until you rectify the situation. That can make it very expensive to put money in that account if it turns out that you’re really not allowed to do so.
What are those income limits?
First, you can only directly contribute to Roth IRA from taxable compensation — such as money earned by you or your spouse through working as an employee or as a self-employed business owner. Even if you otherwise have enough money to contribute to a Roth IRA, your contribution can’t exceed your taxable compensation amount.
On the other end of the income spectrum, your ability to contribute starts to phase out when you reach certain income thresholds. For 2021, your ability to contribute starts to phase out at $125,000 if you’re single, $198,000 if you’re married filing jointly, or if you have any income and are married filing separately.
Note that those upper-end income thresholds are based on something known as your Modified Adjusted Gross Income (MAGI). That number includes things like interest, dividends, and capital gains, on top of what you earn through work.
Since your MAGI can often change up to the very end of the year, you might have some great reasons to wait until after the calendar year ends to make your Roth IRA contribution. Now that the year is safely in the past, it’s a great time to start doing the math and seeing if you do qualify to make that contribution.
If your income is too high, are you locked out?
If your income is too high to directly contribute to a Roth IRA, you might still be able to get money into one by using a technique known as a backdoor Roth IRA contribution. With that approach, you make a traditional IRA contribution and then immediately convert the money to a Roth IRA. Since there are no upper income limits for making traditional IRA contributions, that technique is available no matter how high your income gets.
If you had no balance in any traditional IRAs before you made that backdoor Roth IRA contribution, then the treatment of that backdoor contribution is nearly identical to a standard contribution. The biggest difference is that you can withdraw a standard Roth IRA contribution at any time for any reason, and pay no taxes or penalty on that withdrawal. With a backdoor Roth IRA contribution, that money has to stay in your account for five years (unless you’re over age 59 1/2) or you could face a penalty .
If, on the other hand, you had a balance in your traditional IRAs before you made that backdoor Roth IRA contribution, things get a little more complicated. The big difference is that money withdrawn from a traditional IRA has to follow a pro rata rule when determining the taxable impact of that withdrawal. Based on how that rule works, it’s possible for your immediate tax costs to go up when making a backdoor Roth IRA contribution versus what you would have faced had you directly contributed.
That’s not necessarily a deal-breaker, but it is a cost you should recognize before you proceed.
Do note that you can make a contribution to your traditional IRA for tax year 2021 with the intent of making it a backdoor Roth IRA contribution. If you do that, the Roth conversion part will be considered a tax year 2022 conversion, even if the contribution counts against your 2021 limits.
Time’s ticking down, so put your plan in place now
Although the contribution window for Roth IRAs for 2021 is still open, you only have until April 15 to get your money in the account for it to qualify for that tax year. So if it’s something you’re eligible for and would like to do, get started now and give yourself a decent shot of making it happen before that window slams shut.
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