A Roth IRA is an alternative type of individual retirement account that allows individuals to make after-tax contributions and leave their money in the account to grow during their lifetime. This type of IRA is attractive to people who don’t need the tax deduction, because they aren’t required to take distributions later in life. But Roth IRAs also may have disadvantages as a retirement investment option.
Find out more about some of the disadvantages of Roth IRAs, including contribution limits, tax issues, and penalties.
- Although Roth IRAs have advantages, they aren’t for everyone.
- You can’t make tax-deductible contributions to a Roth IRA.
- You can’t roll over (move) a Roth IRA to a traditional retirement plan.
- Roth IRAs can’t be included as an option in an employee retirement plan.
- Roth IRAs aren’t as flexible as traditional brokerage accounts because there are qualifications on Roth withdrawals.
Roth IRA Contributions Aren’t Tax-Deductible
A traditional IRA allows individuals to make before-tax contributions for retirement, and these funds aren’t taxable until the year they are withdrawn. In the same way, a 401(k) plan or other type of employee retirement plan allows employees to contribute to a retirement account through their employers and then take a tax deduction.
But if you contribute to a Roth IRA, it must be with after-tax dollars, so your contributions aren’t tax-deductible. You must pay the taxes on the income before you make the contribution, and you can’t defer the taxes to a later year.
Everyone’s situation is unique, and the decision to set up a pretax or after-tax retirement account depends on your individual situation. Get help from both a licensed tax professional and an investment advisor before you decide.
Roth Contributions Are Limited
The amount you can invest in a Roth IRA each year is limited, based on your filing status and your modified adjusted gross income (MAGI). The maximum amount changes every year. For 2022, for example:
|If your filing status is:||And your MAGI is:||You can contribute:|
|Married filing jointly||Under $204,000||Up to the limit (see below)|
|Married filing jointly||$204,000 or more but less than $214,000||A reduced amount|
|Married filing jointly||$214,000 or more||$0|
The 2022 limit on Roth IRA contributions is the lesser of:
- $6,000 ($7,000 if you’re aged 50 or older) or
- Your taxable compensation for the year
These limits are the same as traditional IRAs but lower than some other types of IRAs. For instance, the 2022 limit on a SEP IRA for business owners and employees is the lesser of $61,000 or 25% of compensation for each participant.
You may have both a Roth IRA and a traditional IRA or 401(k), but the combined limit for the year is still the same ($6,000 for 2022, for example).
Employers Can’t Set Up Roth IRAs For Employees
Employers have several options for setting up and contributing to retirement savings plans for employees, but these don’t include Roth IRAs. Employers can’t set up Roth IRAs and make direct contributions to them for employees, but any employee can use income from work to make their own Roth contributions.
An employer can set up a Payroll Deduction IRA with a financial institution. Individual employees can then designate amounts from their pay (after tax) to make contributions to their own Roth IRAs. The employer can’t contribute to individual employee Roth IRAs through this plan, however.
Penalties for Unqualified Withdrawals
Standard brokerage accounts don’t have penalties on withdrawals. If you put money into an investment account with a broker you can take it out any time and pay the tax in that year. There’s no limit on how much you can take out or when you can take it.
But if you take money from a Roth IRA and it doesn’t meet IRS requirements, you may have to pay a penalty.
You may be penalized with an additional 10% tax on the amount of the distribution. Penalties may apply if you take a distribution within five years from the first tax year of your account or if you take the distribution before age 59 1/2. You or your beneficiaries aren’t penalized if the distribution is held for at least five years and is:
- Due to disability
- Upon or after death, or
- Used for qualified higher-education expenses, among other exceptions
You can take a one-time distribution to help buy your first home. The exception allows you to take up to $10,000 out of a Roth IRA to pay for specific types of costs without a penalty.
Roth IRAs Can’t Be Changed to Other IRA Types
You may be able to transfer amounts from traditional IRAs and certain other types of retirement accounts into other IRAs, including Roth IRAs. These are called rollovers, as compared with distributions, because you don’t have access to the funds; they go directly from one IRA trustee to another.
You may be able to roll over amounts from a qualified retirement plan into a Roth IRA, and you must pay taxes on any untaxed amounts at this time. But you can’t do a rollover of a Roth IRA to a traditional IRA.
Frequently Asked Questions (FAQs)
Are Roth IRAs safe?
Roth IRAs are safe if they are invested with financial institutions that are members of the Securities Investor Protection Corp. (SIPC). This organization protects investors up to $500,000 for securities and cash left in financially troubled or bankrupt brokerage firms. Most brokerage firms are members, but it’s a good idea to check the status of the firm you want to use before you invest.
How do you open a Roth IRA?
To open a Roth IRA you will need to find a financial institution or brokerage firm to manage your investments (stocks, bonds, etc.) and help you complete the paperwork. You will need to complete IRS Form 5305-R or a similar form setting up your Roth trust account. Once everything is activated with your brokerage firm, you can make your first contribution and decide how you want to invest it.
IRS. “IRA-Based Plans.”
IRS. “IRA FAQs.”