Are You Too Old to Benefit from Opening a Roth IRA?

As workers are staying in the workforce longer and living longer than ever before, the question they may ask is, "Am I too old to open a Roth IRA and reap the benefits?"

Roth IRAs, a type of retirement savings plan that employees and self-employed individuals can use to create tax-free retirement income, was introduced in the law 20 years ago. Yet fewer than 20% of individuals have Roth IRAs. That's a shame because there are a number of reasons Roth IRAs can be beneficial for workers of any age, including older workers.

Distributions from Roth IRAs are tax-free if they are “qualified.” This means that the distribution is made after the five-year period beginning within the first taxable year for which a contribution is made to your Roth IRA, and it is:

• Made on or after you attain age 59½
• Made because you are disabled
• Made after your death to your beneficiary or your estate
• Is a one-time distribution up to $10,000 to pay first-time homebuying costs

Thus, if you’re 66 years old and make a Roth IRA contribution for 2017 on July 15, 2017, you can take a tax-free distribution beginning on January 1, 2022 (when you’ll be 71 years old), which is five years from the start of the year in which the contribution was made. (This is true even if you stop working and contributing before January 1, 2022.) If you make another contribution for 2018, the five-year period relates back to the first contribution made for 2017.

There are annual limits for contributions to Roth IRAs; contributions cannot exceed earned income for the year, and the amount of the contribution is limited or barred entirely if your income for the year is over a threshold amount. For 2017, the contribution limit is $5,500, but those who are at least 50 years old by the end of the year can contribute up to $6,500. These limits apply to all IRAs – traditional and Roth – and you can divide up your contributions. For example,  if a 67-year-old contributes $5,000 to a traditional IRA, an additional $1,500 can be put into a Roth IRA. Contributions to a Roth IRA can be made in addition to contributions to a qualified retirement plan.

If you don’t wait the five-year period to take distributions, you can still withdraw your own contributions at any time for any reason with no adverse tax consequences. Because this represents after-tax money, withdrawals aren’t taxed. And they are not subject to any penalty.

If you take out earnings (interest income, taxable gains and the like that your contributions earned) before the end of the five-year period, they’re taxable and subject to a 10% penalty. But because of this, it’s likely that you won’t touch the money too early unless you really need it.

There’s an ordering rule that characterizes what any distribution you take from a Roth IRA represents. The first dollars are your own contributions, which are tax-free. The next category is from conversions from traditional IRAs and retirement plan accounts to Roth IRAs, which may be partly taxable (the amount related to a conversion of an IRA) and partly nontaxable. (Rollover contributions from other Roth IRAs are disregarded.) Finally, the last category is earnings on contributions, which are taxable, should you make an early withdrawal.

Once you reach age 70½, you are barred from contributing to a traditional IRA, even if you still are working. For other types of qualified retirement plans (including IRA-based plans such as SEPs and SIMPLE-IRAs), contributions are not age-barred, but distributions must begin at age 70½. If you’re still working and want to continue setting aside funds, then using a Roth IRA offers tax advantages (discussed throughout this article) that you can’t achieve in a taxable investment account. There is no age limit on making contributions to a Roth IRA.

Employees with 401(k)s may have the option of making after-tax contributions to a designated Roth account, which are similar but not identical to a Roth IRA. Any employer matching contributions can’t be added to a designated Roth IRA, but distributions from it – of employee after-tax contributions and earnings on them – can become tax-free. One other benefit: There are no income limitations on contributing to a Roth 401(k).

However, unlike Roth IRAs, designated Roth accounts must begin to be drawn down starting at age 70½ (unless you’re still working at the company and the plan allows for postponement of required minimum distributions until retirement). This is so even though the distributions aren’t taxed. But the benefits from this tax-free savings account can be maintained by rolling over the funds to a Roth IRA. More specifically, you can direct the trustee of the designated Roth account to transfer the funds directly to your own Roth IRA (a trustee-to-trustee transfer).

Because there are no required lifetime distributions from Roth IRAs, you don’t have to tap into this tax-free resource while you’re alive. Your beneficiary – the person you designated to inherit your Roth IRA – receives the funds tax-free. If the beneficiary is your spouse, then he or she can roll the funds over to a Roth IRA of his/her own. If the beneficiary is someone other than your spouse, the account must be drained over the beneficiary’s life expectancy (in Table I in the Appendices of IRS Publication 590-B). But the distributions are tax-free to your beneficiary.

Of course, Roth IRAs do not offer any immediate tax benefits as traditional IRAs do – contributions are not tax deductible. If your income is too high, you can’t fund a Roth IRA. And, for the most part, investment losses in Roth IRAs are not deductible. And obviously, older workers don't have the decades that the younger ones do to amass a tax-free retirement fund. However, despite these drawbacks, Roth IRAs offer significant retirement income security and tax advantages for older workers.