Should You Convert to a Roth IRA?

Roth IRAs are trendy alternatives to traditional IRAs, which have more restrictions than a Roth. Understanding how the Roth works will help make the most of assets in the account, including avoiding common pitfalls, if you are considering converting to a Roth IRA. Like any other IRA, the Roth allows investments to grow tax-free, explains the article “7 Mistakes to Avoid With a Roth IRA” from U.S. News & World Report.

Some of the more common mistakes I see made with Roth IRAs as an Austin estate planning attorney:

Not asking if Roth IRAs are safe. Account owners may contribute a certain amount yearly if they meet the eligibility requirements. You can allocate funds to different types of investments, including stocks, bonds, exchange-traded funds, and mutual funds. Funds placed in a Roth IRA are after-tax dollars—they are taxed as income when put into the account. Investment gains and withdrawals are tax-free, which is part of the appeal of converting to a Roth IRA. They are considered relatively low-risk investments.

Can you lose money in a Roth? Any account can lose money depending upon the investments you select. Be sure that investment accounts are allocated according to your risk tolerance.

Don’t access funds earlier than permitted. Once you turn 59 ½, you may make withdrawals. Taking out funds earlier may generate taxes and penalties. Sometimes, you might qualify for a hardship withdrawal if you lose your job or have high medical bills not covered by insurance.

Not having earned income. One of the requirements for using a Roth is that the owner must have earned income in the calendar year of the contribution. For example, if you open a Roth IRA for a child, they’ll need proof of wages, such as a W-2 for part-time work. Taxable compensation is a requirement for a Roth IRA.

Contributions if your salary is too high. Roth IRAs have income thresholds, so your contribution limit is based on your salary. You should be cautious of this potential pitfall if you are considering converting to a Roth IRA. You may run into tax issues if you exceed the limit but continue to fund the account. You can contribute the full amount if you file single and earn less than $138,000. Your contribution limit will be reduced if you make at least $138,000 and less than $153,000. You cannot contribute to the Roth if you earn $153,000 or more. The contribution reductions for married couples filing jointly begin at $218,000 and phase out entirely at $228,000. The IRS typically charges a 6% tax on Roth IRA contributions above the limits, so be mindful of these guidelines.

Don’t overlook spouse eligibility. There’s no such thing as a joint Roth IRA, but there is a spousal Roth IRA. If a couple files a joint tax return and one spouse is not a wage earner, they may open a Roth IRA for a nonworking spouse. This allows the working spouse to contribute to their own Roth IRA and the Roth IRA of their nonworking spouse. This gives the spouse who isn’t working an opportunity to save for retirement.

Reference: U.S. News & World Report (April 129, 2023) “7 Mistakes to Avoid With a Roth IRA”