Opening a Roth IRA can be an excellent decision to make for retirement. This account offers its holders more flexibility than the traditional IRA, and they can receive many benefits in their retirement. Most importantly, account holders can have tax-free growth on their investments and withdraw contributions anytime they want and can avoid penalties if they meet certain criteria. But do you have to report your Roth IRA on your tax return? The article will provide an outline of a Roth IRA and help answer this important question.
What Is a Roth IRA?
A Roth IRA is an individual retirement account that allows account holders to make tax-free withdrawals if they meet certain conditions. The first condition is that they own the account for at least five years. Additionally, they have to be 59 and a half or older, use the money to buy a first home, or have a disability.
Also important to note is that there is a limit on the amount of money that can be deposited into a Roth IRA. The IRS (Internal Revenue Service) sets the limit and changes it periodically. Currently, it stands at $6,000. That means people can deposit up to $6,000 per year to their accounts, or $7,000 if they are 50 or older.
Difference Between Traditional and Roth IRA
Many compare Roth IRAs to traditional IRAs because, in principle, they are very similar. The only difference between the two is the way they are taxed, which gives the advantage to Roth IRAs over their traditional counterparts.
When a deposit is made to a Roth IRA, the person depositing the funds pays the taxes on that money upfront. That is called after-tax contribution, and because of it, you won’t have to pay income tax when making qualified withdrawals money from your retirement account.
On the other hand, traditional IRAs are funded with pre-tax dollars. That means there is a tax deduction on a deposit, but whoever wants to withdraw the money will have to pay taxes every time they do so.
This difference between the Roth IRAs and traditional retirement accounts can be a deciding factor in choosing one over the other. If people require immediate tax deductions to help their current financial status, they should consider traditional IRAs. But if they can pay the taxes upfront, without significant effect on their budget, Roth IRAs might be a good choice.
Eligibility for a Roth IRA
Several factors determine eligibility for a Roth IRA, earned income being one of those. What is considered earned income, and how to obtain it?
Firstly, individuals can work for an employer and earn money that way. In this case, their salary is their earned income, as are their bonuses, tips, and other commissions. Or they can run their own businesses and obtain eligible income that way.
But there are also other ways of earning money that qualify someone for a Roth IRA. Those include:
taxed alimony
untaxed pay earned serving the military
military differential pay
The second qualifying condition is overall income. The IRS determines the limit on how much someone can earn annually and be eligible for a Roth IRA, so people who want to open this account need to be below that line. The limit factors in two things — an individual's modified adjusted gross income (MAGI) and their filing status.
To put the above rule into concrete terms, if someone’s filing status is single and their MAGI is higher than $140,000, they cannot contribute to a Roth IRA.
However, being too young or too old to contribute to this type of retirement account should not be a concern. There is no age limit determining Roth IRA eligibility. Both teenagers with any employment (part-time or full-time) and employed people over 70 can fund a Roth IRA.
Do You Have to Report Roth IRA on Your Tax Return?
The answer to this question is no; Roth IRA doesn’t have to be reported on a tax return. However, Roth IRA holders ought to keep records of their Roth IRA contributions yearly, together with their other tax obligations. This way, they can show their bank that they have owned the account for five years and avoid paying taxes and penalties when withdrawing money. Every year when individuals deposit money into their Roth fund, they will receive a form from their trustee listing their Roth IRA contributions (Box 10).
For further questions regarding this matter, such as understanding what is the 5-year rule for Roth IRA, seek the help of professional financial advisors.
Disclosure: Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax, legal, or investment related advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earning prior to age 59 ½ or prior to the account being opened 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
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This material was prepared for The Kelley Financial Group.