- September 26, 2023
- Colton Owen
Planning for retirement can be confusing, complicated, and a lot of times – overwhelming. One great tool that can be used to benefit retirees in the long run are Roth IRAs / Roth 401(k)s.
However, according to Elizabeth O’Brien of Barron’s, “Eight in 10 retirement plans administered by Vanguard offered a Roth option as of the end of 2022, yet only 17% of participants in such plans took advantage of it.”
So why is that? Should you be contributing to a Roth Account?
Roth IRA / 401(k) Advantages
In a normal retirement account (Traditional IRAs & 401(k)’s), taxes on contributions are tax deductible, and taxes are deferred until withdrawals during retirement. A Roth account functions by taxing an individual on their contributions, but when withdrawals are taken, they are tax-free.
Furthermore, when investing in a Roth IRA or a Roth 401(k), it normally makes the most sense to contribute to these accounts in low-income years so that the investor is taking full advantage of the tax benefits available to them.
So why do so many people neglect to invest in a Roth IRA / 401(k)?
Roth IRA Contribution Limits and Phaseouts
IRAs are limited to a yearly contribution of $6,500 per year between all of an individual’s Roth and Traditional IRAs. This, along with income phaseout, can keep investors from being able utilize Roth IRAs. The contribution limits and income limits are listed below.
| Year | Contribution Limit |
| 2023 | $6,500 ($7,500 if age 50 or over) |
| Tax Filing Status | Modified AGI | Contribution Amount |
| Married Filing Jointly | < $218,000 | Up to the limit |
| Married Filing Jointly | ≥ $218,000 but < $228,000 | Amount reduced |
| Married Filing Jointly | ≥ $228,000 | Zero |
| Single, Head of Household, Married Filing Separately | < $138,000 | Up to the limit |
| Single, Head of Household, Married Filing Separately | ≥ $138,000 but < $153,000 | Amount Reduced |
| Single, Head of Household, Married Filing Separately | ≥ $153,000 | Zero |
Now, one might ask, “How can I save in a Roth IRA if my MAGI is higher than the limit?” Don’t worry! There is a way!
Roth IRA Conversions Explained
A Roth Conversion is the process of taking the funds in a Traditional IRA or Qualified Retirement Plan and transferring them to a Roth IRA. An investor using this strategy is not subject to the income constraints of the Roth IRA, nor are they subject to the contribution limits that we discussed earlier.
However, while a Roth Conversion is a savvy way for an individual to invest in a Roth IRA, the investor must be aware of the tax consequences of this move.
Remember, Traditional IRAs are accounts where you can defer taxes until withdrawal of the funds at a later date. So, when you move money from a Traditional IRA to a Roth IRA, that is considered taxable.
Roth IRA Withdrawal Rules
We have already discussed that withdrawals from a Roth IRA are tax-free. However, an individual who takes money out of a Roth IRA must follow a couple of rules.
The investor who is drawing down on their Roth IRA must be at least 59 ½ years old. If the person is younger, their withdrawal will be subject to a 10% early withdrawal penalty.
Also, the investor is subject to a “five-year holding period” requirement. This means that funds must be settled in the Roth IRA for at least five years before taking a withdrawal. Withdrawals taken before five years are subject to taxes.
There are exceptions to these rules (first-time home purchase, college expenses, and birth/adoption expenses), but it is always a good rule of thumb to ensure that your withdrawals are within the guidelines given by the IRS.
Does a Roth IRA make sense for you?
Determining whether an investor should contribute to a Roth IRA is a more difficult decision than you might think. Time horizon, current income, expected income, goals, and current investment accounts all play a role in the decision-making process.
With that being said, there is no denying the advantages that tax-free withdrawals during retirement can have on a financial plan.
Concerns or questions about your retirement plan? Contact Financial Synergies today.
We are a boutique, financial advisory and total wealth management firm with over 35 years helping clients navigate markets and developing custom financial plans. To learn more about our approach to financial planning please reach out to us. One of our seasoned advisors would be happy to help you build a custom financial plan to help ensure you accomplish your financial goals and objectives. Schedule a conversation with us today.
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