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If you’re currently living and working in the United States, you are more than likely to have heard about the Roth Individual Retirement Account (IRA). It is one of the most popular retirement plans sanctioned by the Internal Revenue Service (IRS) other than 401(k), 403(b), 457(b), traditional IRA, or guaranteed income annuities (GIA).

You should start thinking about an additional retirement plan. Most people typically have a 401(k), the most popular retirement plan offered by companies in the US. According to recent research from Willis Towers Watson, of the 86% of Fortune 500 businesses it accommodates, 100% of these firms only offer 401(k) plans.

US regulation allows you to have both a 401(k) and an IRA (traditional or Roth). As defined benefit plans have broadly not been used since the 1970s, a Roth IRA can be an alternative option for managing your future retirement funds. With the help of internet and technology advancement, setting up the new Roth IRA account is easy and painless. However, we at Cameron James urge you only to discuss the matter with an Independent Financial Adviser.

The regulated financial adviser will give you a comprehensive judgment on your financial state. By doing so, they should explain the best option for you in detail. A diligent financial adviser should warn you about the risks that may arise no matter which retirement plan you choose.

So, would you like to set up a new Roth IRA? Or, do you currently still need to consider further which retirement plan is best for you? Let’s dive in.

What is a Roth IRA?

The name derives from US Senator William Roth, who with Senator Bob Packwood proposed the idea in 1989. The retirement plan was enacted as a part of the Taxpayer Relief Act of 1997. It is similar to the traditional IRA in most ways.

According to the IRS, there are fundamentally five factors that differentiate Roth IRA from Traditional IRA. They are:

  1. The contribution to a Roth IRA cannot be tax deducted.
  2. Qualified distributions are tax-free if one meets the requirements.
  3. After reaching age 70½, you can continue to contribute to a Roth IRA. However, you can no longer make contributions to a traditional IRA once you reach 70½.
  4. You can leave sums in your Roth IRA while you live and transfer them to your spouse or other recipients.
  5. When setting up, you must identify the account as a Roth IRA.

What makes Roth IRA great is that at retirement, you can withdraw funds tax-free. Therefore the pension schedule requires you to pay a tax bill on your contributions. However, when the time comes (when you reach age 59½ or later), you can have tax free withdrawals plus earnings. In contrast, your money will be taxed on withdrawal in a traditional IRA.

If you are a salaried employee or a business owner, you can have a Roth IRA, assuming you have taxable income.

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IRS rules stipulate that only earned income can be contributed to a Roth account. Furthermore, there are four types of income that you cannot contribute to a Roth IRA. The excluded types of income include rental income or other profits generated from property maintenance, interest income, pension or annuity income, and stock dividends and capital gains.

Once your account is set up, you can allocate your cash to your investment selection which can be withdrawn later to your bank account. If you don’t have previous investment knowledge or experience, it is best to speak with a trusted financial adviser to help choose your investments. Once you are sure about it, you can set up a Roth IRA offered by custodians (commercial banks, brokers, etc.) as suggested by your financial adviser.

Roth IRA funds can be invested into almost any investment vehicle. These include mutual funds, stocks (income-oriented stocks and growth stocks), bonds, exchange-traded funds (ETFs), real estate investments (either indirectly or directly).

In order to make a direct investment in real estate, your account must be self-directed, not attached to a bank, investment company, or brokerage. The IRA custodian must also offer real estate as part of its investment choice; these custodians may have higher fees for dealing with these more complicated assets.

Therefore, investing in real estate through an IRA is only suitable for savvy investors. Like any other investment activity, your attitude towards the risks it carries is fundamental. Therefore, you should discuss the matter thoroughly so that you can decide on the best investment option.

Is a Roth IRA Better Than a Traditional IRA?

At least there are three ways it is better than the traditional one. We hope it can also give you more clarity and understanding.

1. More flexible and inheritance benefits

The Roth IRA provides you greater flexibility than the traditional IRA, meaning more freedom. If you have other sufficient funds to enjoy your retirement days, you can leave your Roth IRA untouched. In addition, unlike the traditional IRA holders, you are not required to make an annual withdrawal, commonly known as the required minimum distributions (RMDs). Therefore you can maximize the amount you can pass on to your children.

An RMD should be withdrawn no later than April 1 of the year following the year in which they reach age 72. Failed to do so, or the amount of withdrawn funds is insufficient, you may have to pay a 50% excise tax on the amount not distributed. You may accumulate wealth, but the US Government dictates the rule to generate income from taxation. Remember, money withdrawn from a traditional IRA is taxable.

2. Tax-free IRA withdrawals and inheritance

The second reason to choose the plan is that it gives you peace of mind during retirement. As the money withdrawn from the Roth IRA is tax-free, you can say goodbye—at least partially—to the taxman. In addition to that, upon your death, the money is passed to your spouse tax-free. You won’t give them additional tax related headaches.

This estate planning strategy, known as “the stretch IRA”, allowed beneficiaries of inherited Roth IRAs to keep income, potentially for generations, and take advantage of the tax-deferred or tax-free growth within the account.

However, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, beneficiaries other than surviving spouses can no longer benefit from the stretch IRA. In addition, other beneficiaries of Roth IRAs will have to withdraw inherited assets within ten years of the original holder’s death.

You should not be too worried. In addition to the surviving spouses, this new rule does not apply to minors, disabled persons, or the chronically ill and other beneficiaries who are not more than ten years younger than the original account owner.

3. Tax-free earnings

The Roth IRA’s holders may expect their investments to succeed. The fruit of those investments is called earnings. With a Roth IRA, your earnings grow tax-free. Importantly, the earnings you withdraw in the future won’t be taxed if it meets the IRS’ requirements.

This can be particularly beneficial if you are a young person or expect to be in a higher tax bracket at retirement. You can end up paying less tax in your lifetime by paying in a smaller tax bracket now and enjoy more pension income at retirement.

However, the closer you are to retiring, the less time your assets have to grow to recoup the upfront tax payments. Therefore, it is best to contact an advisor to see which option is best for you.

How Do I Open a Roth IRA Account?

You must evaluate two major requirements in terms of filing status and modified adjusted gross income (MAGI) before choosing whether to create the account. The filing status determines US residents’ or employees’ tax bracket. There are currently seven stratified tax brackets categorized by the government, where the lower one will pay the lowest rate of tax. It is closely tied with someone’s marital status.

As per the regulation, there are five categories of US taxpayers, namely single, head of household, married filing separately, married filing jointly, and qualifying widow(er) with dependent children. The second requirement, MAGI, is a tax term and is more complex. It strictly decides whether you can contribute to Roth IRA or not.

MAGI’s simple definition is your adjusted gross income (AGI) plus a few items. In addition to its influence on Roth IRA, it also plays a significant role in several tax benefits, e.g., Net Investment Income Tax, Premium Tax Credit, Education Credits, etc.

To determine your MAGI—so it meets Roth IRA’s requirements—you need to add your AGI (which can be found on your Form 1040) with the following:

  • Any IRA allowance you have taken
  • Any deductions you have taken on student loans or lessons
  • Income or loss of liabilities
  • Foreign revenue excluded
  • Losses of rent if you own a property
  • EE savings bonds interest used to cover college costs
  • Half your tax on self-employment
  • Costs paid by the employer for adoption
  • Losses resulting from a public partnership

If those still seem exhausting, do not worry. Cameron James, a qualified and regulated financial institution that also acts as independent financial advisers from can help calculate your MAGI, so that you can find out your eligibility in joining a Roth IRA.

In addition, the IRS also periodically adjusts annual income limits for each filing status category. The income limit for 2021 can be found here. For 2021, the IRS regulated the maximum annual IRA contributions you can make to $6,000. If you are 50 years old or up, you can contribute to the account up to $7,000.

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Another common question asked by clients is at what age can you open a Roth IRA?

You can open a Roth IRA at any age when you feel it can be best for you. If you start contributing to Roth IRA at a young age, you can take advantage of paying into a lower tax bracket, rather than taking withdrawals at a higher tax bracket.

According to a CNBC article written by Alicia Adamczyk, many experts believe that the Roth IRA is better than the traditional IRA. It is also more attractive than traditional IRA as income tax rates are extremely low due to the Tax Cuts and Jobs Act of 2017.

Many experts even suggest individuals open up a Roth IRA account for their spouse, formally named Spousal IRA, if the couple file a joint tax return.

What is the 5-Year rule for Roth IRA?

The five-year rule is a five-year waiting period on certain withdrawals. It particularly applies in three conditions:

1. For withdrawals

In addition, having reached age 59½, you have to have owned the Roth IRA for at least five tax years. The five-year period starts on the first day of the tax year you contributed to any Roth IRA.

2. For Roth IRA Conversions

Roth IRA conversions involve convert of traditional IRA assets to a Roth. Conversion of IRA to a Roth prevents people from using the Roth conversion as a means to avoid penalty fees, the government regulates anyone—who wishes to convert their traditional retirement account into a Roth IRA—to wait for five years before taking withdrawals.

3. For Inheritor of Roth IRA

As a spouse

If you are the spouse of the original account holder, you can set up an inherited IRA, which follows the 5-year rule. You can take the funds anytime you like, but you have to withdraw them entirely by December 31 of the fifth year after the year of the original holder’s death.

As a non-spouse inheritor

Similar to the spouse inheritor, other beneficiaries can also set up an inherited IRA account by using the 5-year rule. Those who fall into non-spouses include children, grandchildren, other family members, and friends.

Both inheritor categories can take lump-sum distributions, from which they take all the funds at once. This option requires the original account holder to have owned it for at least five years. If not, the earnings are taxable.

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Should I Transfer My 401(k) into a Roth IRA?

Roth IRA offers more flexibility than traditional IRA or 401(k) plans as there are no required minimum distributions in it. However, there is a limit to what you can contribute to your retirement account. In 2021, the maximum annual contribution you can make is $6,000—similar to the previous year.

You can and should roll over your 401(k) into a Roth IRA, especially once you quit your job, and your new employer doesn’t offer a 401(k) plan. Although it can be left in the hands of your former employer, you could benefit more from the flexibility provided by a Roth IRA. It gives you the freedom to invest.

Can I Have Both 401(k) and Roth IRA?

Yes, you can. But you must have understood that each plan has its annual contribution limits. By the time your calculation is done, you should still consider that the main aim of this decision is to give you more advantages (especially regarding taxable retirement funds) in the future.

Another consideration is your marital status and whether you have a child or not. Your marital status (tax term: filing status) can affect your eligibility to participate in any sanctioned retirement plan. Alternatively, you can choose a Roth 401(k) plan, provided your employer supports this retirement plan for its employees.

Plan Your Retirement with Cameron James

Having read the above explanations, you may have pondered the Roth IRA for your future funds. Cameron James warmly invites you to discuss this with us further. Not only qualified and regulated, our financial advisers respectively have years of experience in finance and pension planning.

About Dominic Murray

My career in financial services began in 2010 during my Bachelor of Science (BSc) Undergraduate degree at Aston University in England. The degree required me to spend a year abroad working with an established organisation.

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