Roth IRA, business

As a business owner, you have an assortment of retirement options. These range from the straightforward, think an Individual or Simple 401 (k), to the more complex, such as a Money Purchase Plan or Profit Sharing. However, for many, the creme de la creme is a Roth IRA.

Why? Because not only is able to set and manage, it also comes with tax advantages. These are so favorable that a Roth IRA can help you save for retirement and build your wealth tax-free. But, before you you dump all of your savings into a Roth, you should familiarize yourself with it. After all, you want to get the most bang for your buck without getting penalized, right?

What is a Roth IRA?

Established in 1997, a Roth IRA is simply an individual retirement account (IRA). Named after it’s sponsor, Delaware Senator William Roth, it’s similar to a traditional IRA. Both have contribution limits and deadlines. There are also no minimum investments or fees. However, the key difference is how they’re taxed.

With a traditional IRA, you pay taxes on the back end. That means you can deduct your contributions in the year you deposited them. But, you will have to pay taxes on withdraws later.

That’s not the case with a Roth IRA. Because you contribute after-tax dollars, your money grows tax-free. Moreover, you’re allowed to make tax- and penalty-free withdrawals after age 59½.

And. as long as you have an earned income, anyone is eligible to open a Roth IRA. In fact, you can contribute at any age — which is great if you want to get a head start on your retirement savings or want to keep growing your saving in retirement. The caveat is that you must be under the income limit. While this varies annually, in 2020 that limit was limit for singles is $139,000 and $206,000 for married couples.

What are the pros and cons of a Roth IRA?

While I did go other some of these, I feel that the advantages of disadvantages of a Roth IRA were glossed over. So, to make sure that it’s the right account for you, let’s dig a little deeper.

The cons of Roth IRA.

Let’s just get the bad out of the first.

Taxes are paid upfront.

That’s all well and good for your future self. But, what if you’re struggling to save right now? You may be better off with a traditional IRA so that you can receive a tax deduction for contributing.

The maximum contribution is low.

While this can change, in 2020 you can only contribute up to $6,000 to a Roth IRA — which was the same in 2019. If you’re over the age of 50, however, you can put in an additional $1,000 to catch-up on retirement. Because this isn’t much, you’re probably going to need to invest elsewhere as well, such as a 401(k) that has a limit an annual contribution limit of $19,500 in 2020.

You’re going to have to set it up yourself.

Sure. You can set up automatic contributions from your bank account. However, you’re still going to have to initially set this up yourself, as opposed to a 401(k) that an employer may have auto-enrolled you into.

Be aware of income limits.

According to the IRS, income limits are based on modified adjusted gross income. For instance, if you’re single you’re eligible as long as you have a MAGI of less than $124,000. If so, then you are permitted to contribute the maximum amount of $6,000 ($7,000 if age 50 or older) to a Roth IRA.

If you earn more than that, you can still contribute to a reduced amount. The catch? Your MAGI must be between $124,000 and $139,000. But, once you cross that $139,000 amount, you’re no longer eligible.

Married couples with a modified Adjust Gross Income (AGI) of less than $196,000 can also contribute up to the limit. If your AGI is between $196,000 and $206,000, then you may qualify to make reduced contributions. Couples with an AGI of $206,000 or higher do not meet the criteria.

The pros of Roth IRAs.

Despite the drawbacks, there are upsides to Roth IRAs.

Your savings grow tax-free.

Again, since you’re paying taxes upfront on a Roth IRA, anything that you earn is tax-free. What’s more, when you do reach retirement age, you won’t be taxed whenever you make a withdraw. For those who have a higher tax rate in retirement, that’s welcome news for your savings.

No required minimum distributions.

Once you reach the age of 72, you are required to start pulling your money out of your traditional IRA account. That’s not true with a Roth.

You can withdraw your contributions.

Unlike most other retirement accounts, it’s easy to withdraw your contributions. Even sweeter? You won’t get penalized. That means a healthy Roth IRA could be used for emergencies or growing your business.

You get tax diversification in retirement.

If you have a traditional IRA or 401(k) you’ll have to pay taxes on withdraws in retirement. You may also be taxed on a portion of your Social Security income. And, that’s no Bueno if you’re trying to stick to a budget in your golden years.

That’s not the case with a Roth IRA. You have the flexibility to juggle your distributions between your accounts. As a result, you can avoid getting placed in a higher tax bracket.

What else should I know about Roth IRAs?

Let’s tie up some loose ends here and quickly answer some other questions that you may have.

  • What is earned income? It’s simply the money you’ve received from wages, salaries, tips, bonuses, commissions, and self-employment income. It does not include alimony, child support, income from rental property, interest and dividends from investments, retirement income, social security, or unemployment benefits.
  • As a business owner, does my contribution limit change? No. Just like everyone else you can only contribute as much as $6,000 to an IRA — or $7,000 if you’re aged 50 and older. Keep in mind though that you must have enough earned income to cover that limit. So, if you earned $4,000, then that’s the amount that you’re allowed to contribute.
  • What happens if I contribute too much? That may notify the IRS, which will probably trigger a penalty. You could ease the pain by reducing the following year’s contribution by the excess amount. You’ll still have to pay a 6% penalty on the excess that was contributed, but it’s better than having your investment income wiped out.
  • Am I still able to contribute if my income is too high? Yes — via a backdoor Roth IRA. It sounds shady. But, this is where you would deposit money in a traditional IRA and then convert it to a Roth IRA.
  • Can you lose money in a Roth IRA? Sure you can. But, spread out among different types of mutual funds, the risk is minimal.

The bottom line.

An IRA, in general, is an excellent option to save for retirement. A Roth IRA in particular is appealing because it’s incredibly easy to open and maintain. It’s probably just as simple as opening up a checking account. Moreover, there are generous tax incentives and provides steady and continuous growth.

Of course, it’s not without its flaws — namely the low amount of contributions. But, it’s still an excellent option — especially if you want to supplement your other self-employed retirement savings.

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I'm Chalmers and I'm the Co-Founder and CTO of Due.com.

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