Every once and awhile the IRS increases contribution limits or income limits for Roth IRAs. This year, while contribution limits are staying the same, income limits have increased for who is eligible to contribute to a Roth IRA. For 2021, eligible participants may contribute up to $6,000 toward their Roth IRA. If you are older than 50 you can contribute up to $7,000. Contributions can be made anytime until the tax filing deadline.
Earned Income Nuances
Earned income is defined as anything you made from salary, hourly pay, or profits from a small business. Basically, if it’s taxable it counts as earned income. If your earned income happens to be less than $6,000, you may only contribute up to the full amount of your earned income, not the full $6,000. Even if you make no money but your spouse does, you can set up a Spousal IRA and contribute the full $6,000 to both accounts as long as your spouse earns more than $12,000 in a year.
Contribution Strategies
There are a couple of different options when it comes to making contributions. You can contribute the full amount in one payment at any time during the eligible window. Another strategy is what’s called dollar-cost-averaging. This is where you spread your contributions out over the course of the year, whether that’s monthly or quarterly, to average your risks and rewards. By spreading out the contributions you may buy shares when they are priced low or high, but it will average your cost in the end. Since it’s difficult to know when prices will be low, if you contribute all at once, you may be unwittingly buying shares at their highest price point. Dollar-cost-averaging minimizes that risk.
Conversions
When converting funds to a Roth IRA, there are no contribution or income limits. Therefore, if you already opened a Roth account while you were eligible, you can roll over funds from another account into your Roth, no matter the amount. If you are no longer eligible for contributing directly to a Roth, you can use the “backdoor Roth” strategy to benefit from tax-free distributions at retirement. Keep in mind, however, that you will need to pay taxes on any untaxed funds converted and the funds may count as earned income that could bump you to a higher tax bracket. Always consult your financial advisor before converting funds from one account to another.