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Roth IRAs are an excellent way to save for retirement, and they offer many benefits, including tax-free withdrawals and no required minimum distributions. However, several costly mistakes can be made with your Roth IRA contributions and distributions, which can result in significant penalties and taxes. Here are some costly Roth IRA mistakes to avoid.
1. Not knowing the contribution limits:
One of the biggest mistakes is not knowing the contribution limits to your Roth IRA. For 2021, you can contribute up to $6,000 per year if you’re under 50 years old. If you’re over 50, you can contribute an additional $1,000, making your total contribution $7,000. If you exceed these limits, you will be subject to a 6% penalty on the excess amount.
2. Not making eligible contributions:
Another mistake is not making eligible contributions. To contribute to a Roth IRA, you must have earned income. If you’re not working and have no earned income, you’re not eligible to contribute to a Roth IRA. Also, you can’t contribute more than your earned income for the year.
3. Not following the 5-year rule:
The Roth IRA has a five-year rule that determines when you can withdraw your funds tax-free. If you withdraw funds before the five-year period, you may be subject to taxes and penalties. This rule applies to every Roth IRA account you have, so make sure you keep track of the date you opened each account.
4. Not considering the tax implications of Roth IRA conversions:
If you convert a traditional IRA to a Roth IRA or rollover funds to a Roth IRA from a 401(k) plan, you’ll have to pay taxes on the converted or rolled-over amount. If you’re in a high tax bracket, this could be a costly mistake, so make sure you consider the long-term tax implications before making a conversion or rollover.
5. Not considering the impact of Roth IRA withdrawals on your financial aid:
If you have a high-income household and plan to apply for financial aid for your children’s college education, you might want to avoid making early withdrawals from your Roth IRA. Withdrawals from a Roth IRA count as income and could reduce your eligibility for financial aid.
In conclusion, if you have a Roth IRA, ensure you understand the rules and avoid making costly mistakes that could jeopardize your retirement savings. Keep track of the contribution limits, follow the five-year rule, consider the tax implications before making conversions or rollovers, and be mindful of the impact of Roth IRA withdrawals on your financial aid eligibility. With these tips, you can make the most of your Roth IRA and enjoy a comfortable retirement.
Is a 1.35% mutual fund expense ratio fee by my Roth IRA manager too much? I pay the $50 annual fee plus the 1.35%. Am I getting ripped off?
According to line 2 of worksheet 2-1 on IRS publication 590-A, Roth conversions do NOT count as MAGI income, so they do not affect your threshold for Roth IRA contributions.
Might want to add content on the transfer of a roth 401k to a roth ira after retirement and the associated 5-yr rule clock potentially starting over after 401k to ira conversion ouch
The 5 year rule on Roth Conversion makes total sense.
Think about it – If you are liquidating your traditional 401k you have to pay ordinary income tax on it. Next, if you put that money into Roth, it should be given some time to grow so you can take advantage of the tax-free growth. I say even 5 years is a bit short. People should have a longer horizon for that converted money to really extract the tax advantage from those conversions.
If married filing jointly can both I and my wife have separate Roth IRAs and max them out for a total of $12,000?
Define "mess on your hands". If your conversions from IRA puts you over the income limit for a Roth contribution, wouldn't you simply have to pull out your contributions like you never made them?