Individual Retirement Accounts (IRAs) are savings vehicles that allow a tax deduction to be taken when you contribute to the account. The maximum contribution in 2021 is $6,000, and those age 50 and over may contribute an additional $1,000. The income is not taxable while the assets are held in the IRA, however, the distributions are included in taxable income when taken in retirement.
This is where the difference between a Roth IRA and a traditional IRA comes in. A taxpayer who contributes to a Roth IRA does not get a deduction for the contribution, meaning they have to pay full taxes on any amount that goes into the account. From there, however, the earnings grow tax-free and they are generally not taxable when the distributions are made during retirement.
How to Qualify for a Roth IRA
A taxpayer may only qualify to make Roth IRA contributions if their taxable income is within certain limits. Married taxpayers who file joint returns may contribute the full amount if their income is below $198,000 in 2021. A phase-out occurs after $198,000, eventually ending at $208,000, at which point the taxpayer cannot contribute anything if their income is $208,000 or higher. An unmarried taxpayer may make a full Roth IRA contribution if their income is below $125,000 in 2021, with a phaseout up to $140,000, after which point no contribution is allowed.
While the eligibility to contribute to a Roth IRA depends upon the taxpayer's taxable income, anyone may convert their traditional IRA to a Roth IRA. The amount of the traditional IRA is taxable when the conversion is made, meaning they will have to pay taxes based on his income tax rate on the full amount held in the traditional IRA.
Why a Roth IRA is Good for Estate Planning
Roth IRAs also differ from traditional IRAs in the fact that you can let your savings accumulate tax-free in the account over a long period of time without taking the minimum withdrawals. This will most likely lead to you having a significant amount of money in your Roth IRA when you pass away. Once you pass away, the Roth IRA will pass to the beneficiary you named on the account. This means that the assets in the Roth IRA will not have to go through the probate process, unlike your other solely-owned assets. Be sure that your beneficiary designations are up to date, however, as they could end up going through a long and costly probate process if your beneficiary predeceases you and you do not name a replacement.
If you have any questions about the difference between Roth IRAs and traditional IRAs, or if you'd like to have your current estate plan reviewed to see how a Roth IRA could help, please contact our Bryan will lawyers at 979-703-7014 to set up a consultation.