What is a Roth Contributory IRA? [Should You Start One?]

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Most people have heard of a Roth IRA. However, there is a variation on it that goes by the name Roth Contributory IRA and isn’t as well known.

Can it help you? Should you care about it?

In this post, we’ll be taking a look at what exactly a Roth Contributory IRA is and whether the difference between it and the more popular Roth IRA could make a difference for you.

What is a Roth IRA?

IRA stands for Individual Retirement Account and a Roth IRA is an account in which you can contribute after-tax dollars to it. This differs from a traditional IRA in which you may contribute pre-tax dollars into it, thereby not having to pay taxes on the contributed amount for that year.

Contribution limits for IRAs

Max contribution limit for a traditional and a Roth IRA are both the same. You can contribute up to $6,000 for the year 2022. If you’re 50 years of age or older, you may contribute up to $7,000 for the year. If you have a spouse, each of you can open your own IRAs and contribute up to $6,000 each (or $7,000 for ages 50 and older) for a total of $12,000.

Keep in mind that if you own both a traditional and Roth IRA, the contribution limit applies to the combined amount in both accounts. For example, if you have $2,000 for the year in your traditional IRA and want to contribute the rest to your Roth IRA, you can only contribute up to $4,000 in that account.

Income limits for Roth IRAs

In 2023, modified adjusted gross income (AGI) must be as follows to qualify for contributing to a Roth IRA:

  • Married Filing Jointly or Qualifying Widow(er):
    • If your modified AGI is less than $218,000, you can contribute up to the limit.
    • If your modified AGI is between $218,000 and $228,000, you can contribute a reduced amount.
    • If your modified AGI is $228,000 or more, you cannot contribute to a Roth IRA.
  • Married Filing Separately (and you lived with your spouse at any time during the year):
    • If your modified AGI is less than $10,000, you can contribute a reduced amount.
    • If your modified AGI is $10,000 or more, you cannot contribute to a Roth IRA.
  • Single, Head of Household, or Married Filing Separately (and you did not live with your spouse at any time during the year):
    • If your modified AGI is less than $138,000, you can contribute up to the limit.
    • If your modified AGI is between $138,000 and $153,000, you can contribute a reduced amount.
    • If your modified AGI is $153,000 or more, you cannot contribute to a Roth IRA.

Ways to fund a Roth IRA

A Roth IRA can be funded in a couple of ways:

  • Through a conversion of an existing traditional IRA into a Roth IRA
  • Through direct contributions to a Roth IRA

Your Roth IRA can even include a mixture of a traditional IRA that’s been converted along with fresh direct contributions.

What makes the Roth Contributory IRA different from the normal Roth IRA?

Despite the difference in naming, a Roth Contributory IRA is actually the same account as a normal Roth IRA. However, a normal Roth IRA can be called a Roth Contributory IRA if the funds in the IRA were purely via direct contributions, in other words, the money was not rolled over from any other retirement accounts.

Withdrawing from a Roth Contributory IRA – No penalty

You can withdraw from a Roth Contributory IRA starting at 59.5 years of age without penalty, or if you become permanently disabled. There are also special exceptions for if you want to use the money to purchase a home for the first time or to pay for your children’s college tuition.

Withdrawing from a Roth Contributory IRA – With penalty

If you wish to withdraw from a Roth Contributory IRA prior to 59.5 years of age, you can always withdraw any of the directly contributed funds without penalty (the original money you put in). You just can’t withdraw any investment gains as those would be penalized 10%.

For example, say you’ve contributed $10k directly over the years and have made a $2k gain on your investment. Feel free to take out up to $10k without any repercussions. However, if you want to take out your additional $2k early, expect to pay roughly $200 in penalties to do so.

Looking to retire early? See how you can retire by age 55.

Alternatives to Roth Contributory IRA

Traditional IRA: A Traditional IRA allows you to make tax-deductible contributions, which can potentially reduce your taxable income in the year of contribution. The earnings in a Traditional IRA grow tax-deferred, meaning you don’t pay taxes on them until you withdraw the funds during retirement. However, the withdrawals are subject to ordinary income tax rates.

401(k) or Employer-Sponsored Retirement Plans: If your employer offers a 401(k) or similar retirement plan, it can be a great alternative. These plans often provide employer matching contributions, which can boost your retirement savings. Contributions to a 401(k) are made with pre-tax dollars, and the earnings grow tax-deferred until withdrawal.

SEP IRA: If you’re self-employed or a small business owner, a Simplified Employee Pension (SEP) IRA can be an option. It allows you to contribute a percentage of your income to a retirement account, and the contributions are tax-deductible. Similar to a Traditional IRA, the earnings in a SEP IRA grow tax-deferred until withdrawal.

Solo 401(k): Another retirement savings option for self-employed individuals or business owners with no employees (except a spouse) is a Solo 401(k). It works similarly to a traditional 401(k) but is designed for self-employed individuals. It allows higher contribution limits than a Traditional or Roth IRA and provides the opportunity for employer contributions.

Health Savings Account (HSA): While an HSA is primarily used for medical expenses, it can also serve as a supplemental retirement savings vehicle. Contributions to an HSA are tax-deductible, the earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free. Once you reach age 65, you can use the funds for any purpose without penalties (though non-medical withdrawals are subject to income tax).

Also check out SEP vs Simple IRA.

Who can benefit from a Roth Contributory IRA?

Since the primary difference between Roth Contributory IRA and a Traditional IRA is when you get taxed, different people can benefit from each.

If you are someone who will be making and spending more money in the future than right now, a pre-taxed account like Roth Contributory IRA would be best.

If you are someone who will be spending less money in retirement, a Traditional IRA may work better for you.

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