Don’t Make These Mistakes With Your Roth IRA

The Roth IRA is a powerful retirement savings tool. Especially for young people , this is the best way to take full advantage of compound interest while minimizing tax risks. The money you invest grows tax-free, and most people can also withdraw funds in retirement tax-free. However, if you take a few wrong steps along the way, you could end up with unnecessary taxes and penalties. Here are the Roth IRA mistakes you should understand so you can let your retirement savings grow to its full potential.

Ignoring annual contribution limits

The annual contribution limit for a Roth IRA in 2023 is $6,500 for those under 50 and $7,500 for those over 50. What some don’t realize is that these contribution limits apply to the total amount of contributions you make each year to all of your traditional and Roth IRAs.

Attempting to deposit an amount in excess of the annual limit will result in a penalty of 6% of the excess amount unless it is removed immediately. If you exceed your Roth IRA contribution limits, you have until the tax filing deadline and extension to withdraw the excess contributions and any income they generated.

On the other hand, don’t neglect the fact that you can and should make the most of these limits if possible.

Without knowing the limits of income

There are income limits to qualify for a Roth IRA. In 2023, the single-game phaseout range will be $138,000 to $153,000. For married couples filing jointly, the amount ranges from $218,000 to $228,000. Contributions in excess of these limits may result in recharacterization or cancellation of excess contributions.

Withdrawal of earnings too early

Of course, you can withdraw your initial Roth contributions at any time without taxes or penalties. However, withdrawing any earnings before age 59 1/2 will subject you to taxes and penalties on those distributions. There are exceptions for circumstances such as disability, death, or buying a home for the first time, but in most cases you will face an early withdrawal penalty.

Not planning for the required minimum distributions

Unlike a traditional IRA, a Roth IRA has no required minimum distributions (RMDs) during the account owner’s lifetime. However, upon inheritance, beneficiaries other than a spouse must withdraw RMDs from the inherited Roth account. Failure to take an RMD will result in a penalty of 50% of the amount that should have been withdrawn.

Without naming beneficiaries

If you don’t designate beneficiaries for your Roth IRA account, the funds may go through probate after your death . And if your estate is the beneficiary, your heirs may have to empty the entire account within five years. Be sure to fill out the beneficiary form and review it periodically.

Wrong 401(k) rollover

When transferring money from a 401(k) plan to a Roth IRA, it’s important to avoid tax increases. Consult with a financial advisor to determine the best rollover option. Strategies such as direct rollovers and establishing substantially equal periodic payments can provide tax-free conversions. If you know you have retirement funds ready to consolidate, here’s our guide to finding your old 401(k) savings from previous jobs so you can maximize your retirement savings.

Understanding these potential Roth IRA pitfalls is key to maximizing your tax-free growth potential. In general, where you put your money makes a difference in achieving your different savings goals, so here’s our guide to all the different savings accounts you need .