Roth IRAs have allowed people to save for retirement on an after-tax basis since they were enacted in 1998. The money that you contribute doesn’t reduce your taxable income, but the qualified distributions you take in retirement come out tax-free, including the earnings. However, the Internal Revenue Service limits the amount you can contribute each year to your Roth IRA. If you exceed the annual contribution limits, you owe a 6 percent excess contributions penalty each year that you fail to correct the matter.
A rollover from another qualified retirement account does not count against your current IRA contribution limits.
Roth IRA Contribution Limits
As of 2018, the maximum amount that you can contribute each year to your Roth IRA is $5,500 if you are under 50 years old or $6,500 if you are 50 or older. But, you must also have taxable compensation, such as wages, salaries, or self-employment income equal to or greater than your contribution. If you make contributions to a traditional IRA, those contributions will count against your contribution limit to a Roth IRA. Unlike traditional IRAs, Roth IRAs have no age limit on contributions.
Roth IRA Income Limits
If your income exceeds the contribution limits for your filing status, your contribution limit might be reduced or eliminated. For example, if you’re single in 2018, you can make a full contribution if your modified adjusted gross income is less than $120,000. If it is between $120,000 and $135,000, the contribution limit is reduced. If it’s over $135,000, you’re not allowed to contribute directly to a Roth IRA.
Rollovers Don’t Count Against Limits
If you have money in other qualified retirement accounts, such as a traditional IRA, 401(k), 403(b) or even another Roth IRA, you’re allowed to move the money to a Roth IRA. These rollovers don’t count as contributions, so they don’t reduce the amount that you can contribute each year. For example, if you roll over $15,000 from another qualified retirement plan to a Roth IRA, you can still make your annual contribution to your Roth IRA.
Income Tax Consequences of Roth Conversions
Though your annual contribution limit isn’t affected by rollovers, if you move money from a pretax retirement account to a Roth IRA, you must include that amount in your taxable income for the year. For example, if you roll over $15,000 from your former employer’s 401(k) to your Roth IRA, you’ll have to pay tax on an additional $15,000 of income. If you fall in the 20 percent tax bracket, that would mean an additional $3,000 in income taxes.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."