6 Strategies To Make the Most of Your Roth IRA

Tax-Free Income and Withdrawal Flexibility

A casually dressed businessman smiles broadly during a standup business meeting because his Roth IRA is doing well.
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Roth IRAs can supercharge your finances in retirement with the potential for tax-free income. With a Roth IRA, you make contributions using after-tax money. And if you satisfy IRS requirements for qualified distributions, you can withdraw that money—plus any earnings in the account—without paying additional taxes.

Several strategies can help you maximize the benefits of Roth IRAs. Learn more about some unique opportunities these accounts provide and explore ways to get the most out of your Roth IRA.

Key Takeaways

  • Roth IRAs can provide valuable tax-free income in retirement with no need to take RMDs.
  • If you need funds before retirement, these accounts offer flexibility for early withdrawals.
  • The IRS may restrict your ability to contribute, so it’s wise to explore any opportunities you have to open and maintain a Roth IRA.
  • A Roth IRA can shelter substantial gains from taxes, and some assets might be better than others in your Roth.

Maximize Roth IRA Contributions

The IRS limits your ability to contribute to Roth IRAs. So, if you have the funds and desire to contribute, it’s wise to maximize your contributions when you can. The annual contribution limit for 2022 is $6,000, but those over age 50 during the calendar year can make an additional catch-up contribution of $1,000.

If you forget to fund your Roth IRA during the tax year, you can potentially add money to an IRA the next year. You generally have until April 15th to make contributions for the previous year. And if that date falls on a weekend or legal holiday, you can contribute as late as the next business day. That said, it’s best to avoid waiting until the last minute, and it might be less stressful to set up automatic monthly contributions.

You need income to contribute to a Roth IRA, but if your household has too much income, IRS rules might reduce or eliminate the amount you’re allowed to contribute.

Married Filing Jointly or Qualifying Widow Limits for 2022

Modified AGI Contribution Limit
Less than $204,000 Up to the annual limit
$204,000 to $214,000 Less than the annual limit
More than $214,000 None

Single or Head of Household Limits for 2022

Modified AGI Contribution Limit
Less than $129,000 Up to the annual limit
$129,000 to $144,000 Less than the annual limit
More than $144,000 None

Remember that married couples can use either spouse’s income to qualify. But for married couples that file separately, the income limit may be substantially lower and depend on whether or not you lived with your spouse during the year.

Use a Backdoor Roth IRA If You Can’t Contribute Directly

If your income is too high, you’re not eligible to contribute to a Roth IRA. But a backdoor Roth strategy might enable you to save after-tax funds for potential tax-free income.

For a backdoor Roth IRA, you first contribute funds to a traditional IRA. As long as you have taxable income, you’re allowed to contribute to a traditional IRA—but you might not be allowed to deduct the contribution. Then, you can convert the funds in a traditional IRA to your Roth IRA.

When the conditions are right, there are no tax consequences of using a backdoor Roth strategy. However, things can get complicated. For instance, if you convert investment gains, you need to account for those earnings, which might add to your tax liability. And if you have any pre-tax balances in IRAs (as opposed to just nondeductible, after-tax IRA contributions), you may also owe taxes on those funds, if you transfer them.

As you explore the backdoor Roth strategy, verify that the opportunity still exists. Lawmakers have discussed prohibiting backdoor Roth contributions, so the strategy might not work forever.

If your income prevents you from contributing to a Roth IRA, check if your workplace retirement plan offers Roth contributions. You can contribute a substantial amount with a Roth 401(k), and a high income does not count against you.

Short-Term Gains and High-Growth Assets Make the Most of Tax Benefits

If all goes well, you can avoid paying any tax on withdrawals from a Roth IRA. That gives you an opportunity to be strategic about where you hold investments. With smart “asset location,” you can minimize taxes over your lifetime. To do so, use your Roth IRA to hold assets with the most growth potential or the biggest tax impact.

Investors in taxable accounts typically pay the highest tax rates on interest income, short-term capital gains, and some dividends. But you pay lower rates on long-term capital gains and qualified dividends. And assets that have minimal growth, such as cash and similar vehicles, are unlikely to have a big impact on your taxes.

Because of that, your Roth IRA is a good place for your most aggressive investments, according to Ryan Phillips, CFP, Founder of GuidePoint Financial Planning. “This will allow you to capture the greatest amount of tax-free growth,” he says.

Developing a robust asset location strategy and maintaining it over time can be complicated. But if you evaluate holdings in your portfolio along with their tax treatment, you may be able to identify assets that make the most sense for your Roth IRA.

It could also make sense to hold investments that are likely to generate the least favorable types of income—such as short-term capital gains—in your Roth IRA. Meanwhile, investments that produce qualified dividends and long-term capital gains might make sense for a taxable account because of the favorable treatment of those earnings. That said, if you can shelter all investment income from taxation, that’s even better.

Ultimately, the right asset location strategy depends on your situation. For example, you might prefer to hold high-growth assets in taxable accounts if you never intend to sell those holdings. After your death, your heirs might receive a step-up in basis, allowing you and your loved ones to avoid taxation on any gains. Likewise, you might be happy to hold growth stocks in a taxable account if they don’t pay annual dividends, and you’ll only pay long-term capital gains (at favorable rates) when you sell.

Enjoy Penalty-Free Access to Contributions at Any Age

Roth IRAs offer flexibility today in addition to potential tax-free income tomorrow. You can withdraw your regular contributions from a Roth IRA at any time without taxes or penalties—which is unique, when compared to other retirement accounts. You already paid taxes on that money, so you shouldn’t need to pay twice.

However, that flexibility only applies to annual contributions directly to your Roth IRA. Withdrawing from other sources of money might result in taxes. For example, if you pull from the earnings in your account, you may owe income taxes (and possibly additional penalties) if you’re under age 59-1/2, or you haven’t had the account open for at least five years. Also, any money you converted from pre-tax retirement accounts can have strings attached, so check with your CPA before taking a distribution.

Easy access to money in your Roth IRA can be helpful in several ways.Those funds can supplement your rainy day fund if you face an unexpected emergency. Plus, you can use assets from a Roth IRA for a down payment on a home. With a first-time homebuyer exception, you’re allowed to withdraw up to $10,000 of earnings—in addition to your regular contributions—without taxes.

It’s wise to plan and save for financial goals separately so you can track and accomplish multiple goals. Dipping into retirement savings can help with important expenses today, but you may lose progress on long-term retirement goals.

Avoid RMDs If You Don’t Need the Money

With many pre-tax retirement accounts, IRS rules call for required minimum distributions (RMDs) from the account after age 72. However, Roth IRAs do not have RMDs until the account owner dies. Because of that, you can keep a substantial amount in your account and avoid the logistics and deadlines related to RMDs.

If you expect to live a long life, it may be helpful to keep those funds in a Roth IRA for as long as possible. Doing so shelters any earnings on your assets from taxes and preserves your nest egg. Plus, if you’re fortunate enough to have enough assets to pass on to somebody else after death, beneficiaries can receive a tax-free legacy. 

If your designated beneficiary is a spouse, that person can take over the Roth IRA and treat it as their own. That way, they continue to avoid taxation and RMDs. However, most non-spouse beneficiaries need to withdraw the funds within 10 years of death. That’s still a long time to let compounding work.

Name a Beneficiary for Your Roth IRA

Retirement accounts allow you to choose beneficiaries who receive the assets after your death. Adding beneficiaries to your accounts makes life easier for loved ones, and it might help your heirs save money.

A Roth IRA with a designated beneficiary passes directly to the beneficiary without going through probate. As a result, the assets move quickly, and you can reduce any costs associated with probate. Plus, you make your wishes clear so that survivors know what you want to happen with those assets.

Beneficiary designations take precedence over your will, which helps funds move quickly. So, if things change or your will conflicts with your beneficiary designations, it’s critical to understand the outcome. Phillips suggests reviewing beneficiary designations every few years to make sure those instructions still make sense. And he also urges caution when naming minor children as beneficiaries, which may require additional planning and documentation. 

Speak with an estate planning attorney and a tax expert to ensure things go the way you want after your death.

Frequently Asked Questions (FAQs)

What is the most amount of money I can make and still contribute to a Roth IRA?

Your annual limit depends on your tax filing status. Those who are married filing jointly or qualifying widows can make the maximum $6,000 contribution for 2022 with an income below $204,000. Above that, the IRS restricts how much you can contribute, and you can’t make any direct Roth contributions when your income is $214,000 or more. For single filers, that range is between $129,000 and $144,000.

When does it make the most sense for someone to do a Roth IRA conversion?

Roth conversions make the most sense when you think you’re in a relatively low tax bracket compared to future tax brackets. That might be the case in low-income years or in the period between when you retire and when you take Social Security benefits. The strategy can also be helpful if you expect a high income in retirement, as conversions can reduce future RMDs and healthcare costs. Logistically, it’s ideal to convert when you have cash available to pay extra taxes and when markets are down.

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Article Sources

  1. Internal Revenue Service. “Traditional and Roth IRAs.” 

  2. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”

  3. Internal Revenue Service. “Retirement Topics—IRA Contribution Limits.”

  4. Internal Revenue Service. “Roth Comparison Chart.” 

  5. Internal Revenue Service. “Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).”

  6. Internal Revenue Service. “Retirement Topics—Required Minimum Distributions (RMDs).”

  7. Internal Revenue Service. “Retirement Topics—Beneficiary.”