Last fall, the Internal Revenue Service (IRS) announced Roth individual retirement account (IRA) contribution limits and income limits for 2017. There are only minor changes from 2016. As you’re doing your 2016 taxes, think ahead to what it makes sense to budget for 2017.
The limit on contributions to a Roth IRA are unchanged. Individuals may still contribute a maximum of $5,500. People age 50 and over are allowed to add an additional $1,000 for a total contribution of $6,500.
One of the IRS rules on the Roth IRA is that your income can not exceed a certain level of modified adjusted gross income (MAGI). The amount that you can contribute to a Roth IRA first enters a phase-out stage and then goes to zero. The income limits vary according to tax-filing status.
Married taxpayers filing jointly in 2017 enter phaseout at $186,000 and become ineligible at $196,000. Single taxpayers or people filing as head of household enter phaseout at $118,000 and become ineligible at $133,000. These levels are slightly higher than 2016.
IRS Publication 590-A provides a worksheet to figure MAGI and the allowable contribution amounts.
Low- and moderate-income taxpayers may qualify for an additional tax break. The retirement savings tax credit may provide a 10% to 50% tax credit on the amount contributed to a Roth IRA. Taxpayers who are married and filing jointly must have incomes below $62,000; head-of-household filers must have incomes below $46,500; and single taxpayers must have incomes below $31,000.
The tax credit percentage is calculated using IRS Form 8880.
A Roth IRA is a special type of tax-sheltered retirement account. Similar to a traditional IRA, all earnings on funds inside the account accumulate without being subjected to income taxes, and withdrawals may start at age 59½.
There are three main differences between a traditional IRA and a Roth IRA. Contributions to a traditional IRA are fully tax-deductible, but Roth IRA contributions are not tax-deductible. Distributions from a traditional IRA are fully taxable, while distributions from a Roth IRA are tax-free. Traditional IRA accounts must start making distributions when the beneficiary reaches age 70½, while a Roth IRA has no required age for the start of distributions.
The money put into a Roth IRA has already been taxed, so contributions may be taken out at any time without any taxes or penalties.
Whether you should contribute to a traditional IRA or a Roth IRA depends on whether you think your tax bracket will be higher when you retire than it is now, or if you want the contributions to be available in an emergency.
If you have a lower income or if you are younger, you do not need the tax deductionand are better served by using a Roth IRA and taking advantage of years of tax-free compounding. If you have a higher income, you get more advantage from the tax deductions and should choose a traditional IRA. If you have both types of accounts, you have greater flexibility in managing your tax status in retirement.
The most appropriate investment for your Roth IRA is a selection of either growth- and income-oriented mutual funds or an index fund that tracks the S&P 500 average. These types of investments rely on professionals to do the work; they have lower fees and need very little attention until you are getting close to retirement. When retirement is near, look at investment diversification and possibly move your money to more conservative investments.
“Investments with high expected rates of return are best for Roth IRAs since the income grows tax-deferred and withdrawals are tax-exempt. This would include emerging markets stocks, international/developed stocks, and U.S. small cap and U.S. small cap value stocks,” says Mark Hebner, founder and president, Index Fund Advisors, Inc., in Irvine, Calif., and author of “Index Funds: The 12-Step Recovery Program for Active Investors.”
Sophisticated investors with larger accounts can invest in almost any class of investment to boost or shelter returns. Futures, options, real estate, small corporations and venture capital are just a few of the choices available through self-directed retirement plan administrators.
However, most financial advisers would counsel that the bulk of funds should be in more conservative investments.
Roth IRAs can be great investment vehicles for retirement, but their value depends on the financial and life-stage situation of each individual. If you don’t need the tax deduction now, consider opening a Roth – or, possibly, consider having both a traditional and a Roth IRA.