Are You Falling for These 5 Roth IRA Myths?

Key Points

• Roth IRAs allow you to take tax-free withdrawals in retirement.

• You're not required to take withdrawals from a Roth IRA at any time.

• High earners can use the backdoor method to work around the income limits.

• The $23,760 Social Security bonus most retirees completely overlook ›

Retirement accounts are undoubtedly one of the best ways to save and invest for retirement because of the two-for-one benefit they provide: investing for your future and a tax break while doing so.

A 401(k) and traditional IRA allow you to deduct contributions from your taxable income for the year, but a Roth IRA has a unique tax break that offers a longer-term benefit. You contribute after-tax money and then have the chance to take tax-free withdrawals in retirement.

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A Roth IRA's back-end tax break means it operates differently from other retirement accounts. Below are five myths about Roth IRAs that we'll debunk to make it easier to plan around and take advantage of now.

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Myth 1: You must have an employer in order to have a Roth IRA

A major plus of a Roth IRA is that it's not connected to an employer like a 401(k) or 403(b). Anyone can contribute to a Roth IRA, as long as the income is from earned sources.

For example, if you receive a paycheck from an employer or self-employment income, that money is eligible to be contributed to a Roth IRA. Unfortunately, though, money from sources like Social Security, pensions, or investment interest is not.

Myth 2: You can't withdraw early from your Roth IRA

You should always contribute to a retirement account with the thought of keeping the money in there until retirement. However, you're not required to do so. In a Roth IRA, you can withdraw your contributions, but not earnings, at any time without facing an early withdrawal penalty.

As an example, let's imagine you contributed $10,000 to your Roth IRA and the balance has grown to $12,000. In this situation, you could withdraw the $10,000 at any time, but not the $2,000 you earned in interest. Withdrawing any earnings would trigger a tax bill and a 10% early withdrawal penalty.

Once you turn age 59-1/2 and have made your first Roth IRA contribution at least five years prior, you're off the hook and can withdraw earnings tax-free and without penalties.

Myth 3: Roth IRAs have required minimum distributions (RMDs)

Tax-deferred accounts, like 401(k)s, 403(b)s, and traditional IRAs, are set up so that you must begin making withdrawals once you turn age 73. That's because you receive an up-front tax break, and the IRS doesn't want a situation where someone doesn't make withdrawals to avoid paying taxes at all.

Since you contribute after-tax money in Roth IRAs, there's no need for RMDs because you can't be taxed twice. You can keep your investments or cash in a Roth IRA as long as you like, and some people even plan to never make withdrawals in order to allow their investments to keep compounding and eventually pass the account on to an heir once they pass away.

Myth 4: High earners can't have a Roth IRA

One downside of a Roth IRA is the income limits to be eligible to contribute to one. If you're single or file as head of household, the income limit is $165,000. For those who are married and file jointly, the limit is $246,000, and for those who are married but filing separately, the limit drops significantly to just $10,000.

Luckily, if you're over the income limit, there is a workaround, known as the backdoor Roth IRA. With the backdoor method, you initially contribute to a traditional IRA, which doesn't have income limits, and then convert the account into a Roth IRA.

Converting a traditional IRA to a Roth IRA will require you to pay taxes on the amount you're converting, but it could be worth it because of the tax-free withdrawals you'll be able to receive in retirement. If you don't have much time until retirement, the tax hit may not be worth it because of the shorter time for your investments to grow post-tax.

Myth 5: Roth IRAs limit what you can invest in

One of my biggest complaints with a 401(k) is the smaller number of investment options that are provided to you by your plan administrator. This can be limiting, especially for people who want to tailor their portfolio in a way that aligns more closely with their goals, time horizon, and risk tolerance.

By contrast, in a Roth IRA you can invest in any stock, exchange-traded fund (ETF), or bond that you could in a standard brokerage account (with a few exceptions).

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