Small but Mighty: Consider Making a 2023 Roth IRA Contribution (if you're eligible)
This is the time of year when we remind clients who are eligible to consider making a 2023 Roth IRA contribution before they file their taxes—or before April 15, whichever comes first. The maximum contribution for tax year 2023 is $6,500 ($7,500 if you are age 50 or older)—or up to the amount of your earned income if lower than the maximum.
We invite you to click on the links below (or scroll) for more information about the value of a Roth IRA, your potential eligibility, and helping kids or grandkids get started:
Why contribute to a Roth IRA? (And why are you showing me photos of ants?! We’ll explain!)
If my income is too high, do I have another option to contribute to a Roth IRA?
How can I help my child or grandchild start to build Roth savings?
If you would like to make a 2023 IRA contribution, or have questions about your eligibility to contribute, give us a call and we can help. You will want to speak with your tax accountant as well, who can also confirm eligibility and any related tax implications.
Why Contribute to a Roth IRA?
To illustrate the “small but mighty” value of a Roth IRA, we turn to the common ant. Consider these facts:
Ants are strong and can carry 50 times their own body weight.
So, too, a Roth IRA can do some heavy lifting for your investment portfolio, turning today’s relatively small contribution into tax-free growth (and eventually tax-free distributions*) potentially worth multiples of what you originally invested.
Ants are the longest-living insects with lifespans stretching up to 30 years.
Investing in a Roth IRA is a long-term proposition that allows you to leverage the power of time to grow your savings. The younger you are when you start making contributions, the more tax-free growth you’ll enjoy in your later years.
When the time comes in retirement to tap into these Roth IRA funds, you can take distributions without paying any taxes.* And, if you don’t need the money in retirement, unlike a pre-tax IRA, you don’t have to take required minimum distributions (RMDs) when you turn 73 (75 for younger investors) and can keep the funds invested even longer. If you work part time in retirement, you can also continue to fund a Roth IRA. All in all, the productivity of a Roth IRA in building your financial security and net worth can span decades.
Ants are social creatures who build colonies to protect the future of their community.
Within your own family “colony,” the Roth IRA can be one of the most powerful estate planning tools for transferring wealth to the next generation. Unlike an inherited traditional pre-tax IRA, which can potentially be a “tax bomb” for heirs, an inherited Roth IRA must simply be distributed—tax free—within 10 years of inheritance.
Ants are industrious and future thinking … remember the old “Grasshopper and the Ant” fable?
We may be stretching the nature facts here, but you’ll recall in the story, the ants were the “savers” who industriously prepared for the winter ahead (in contrast to the grasshopper who didn’t prepare). Be like an ant.
* Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.
Am I eligible to contribute to a Roth IRA?
Thank you for allowing us to put a “bug” in your ear about making a Roth IRA contribution (and don’t worry, we won’t continue to belabor the ant metaphor). Here are some questions to help determine if you are eligible to contribute:
Did you have earned income in 2023? Earned income is required to contribute to a Roth IRA. Besides salary or wages from formal employment, earned income may also include more informal, non-salaried work—like paid babysitting, dog walking, or even paid chores for kids. Just make sure you have a record of the work completed and that the compensation is reasonable for the task.
What was your modified adjusted gross income (MAGI) in 2023? Each year, the IRS defines income limits that determine whether someone can contribute to a Roth IRA. If you are not sure what your MAGI was, tax software or your tax preparer can help with this. If your gross income was under the limit, your MAGI will be as well.
2023 Single Filers: If your MAGI was below $138,000, you can make the maximum contribution. If it was over $138,000 but less than $153,000, you can make a partial contribution. If it was over $153,000, you are not eligible (but keep reading for another potential option).
2023 Married Filing Jointly: If your household MAGI was below $218,000, you can make the maximum contribution. If it was over $218,000 but less than $228,000, you can make a partial contribution. If it was over $228,000, you are not eligible (but keep reading for another potential option).
Can I still contribute if I (or my spouse) also contribute to a workplace retirement plan? For the Roth IRA, it does not matter if you (or your spouse) are participating in a work 401(k), 403(b) or TSP. This only precludes you from contributing to a traditional pre-tax IRA, which is tax deductible.
If my income is too high, do I have another option to contribute to a Roth IRA?
We’re glad you asked! If your modified adjusted gross income (MAGI) is over the limit, the IRS allows another method (referred to as a "backdoor" Roth) for higher-income individuals to take advantage of the Roth IRA benefits.
It's actually quite simple. You first make an after-tax contribution to a traditional IRA, which has no income criteria for after-tax savings. Then you can immediately convert the account to a Roth IRA. Done.
IMPORTANT: Be aware that, if you already have a pre-tax IRA, using the back-door method could make your after-tax conversion taxable (and potentially impact your tax bracket) and is not advisable. Be sure that you understand the tax implications before deciding to do a conversion.
How can I help my child or grandchild start to build Roth savings?
While you're thinking about saving for your own retirement, you may also want to think about helping a child or grandchild get a jump start on their savings. Just imagine what a small amount of money invested today can turn into with 60+ years of compounded growth!
If a child is of majority age (18 in most states) and has earned income, they can own their own IRA account. Some parents and grandparents then opt to gift the actual IRA contribution, which can be part of a gifting strategy for tax and estate planning.
If a child is a minor but has earned income (e.g., from babysitting, dog walking, or some other form of employment), parents can open a custodial Roth IRA and fund it up to the total amount earned or the $6,500 limit, whichever amount is lower. The adult will be listed as the custodian, but the account will be in the child's name as the owner. The custodian is responsible for documenting the child's income and demonstrating a reasonable wage rate (i.e., not $1,000 per hour to walk Fido). There are also rules as to whether your child needs to file a tax return, so check with your tax preparer.
If you choose to fund a Roth IRA for the child (as opposed to using his or her earned income), this is treated as a gift, and the amount applies to your annual gift exclusion limit of $18,000 in 2024.
Contributions to a traditional IRA may be tax-deductible depending on the taxpayer's income, tax-filing status, and other factors. Like traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. Please consult with a financial professional for more information.
Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.