About 25% of American households own Roth IRA accounts as of 2024. It's important to know you cannot withdraw from a 401(k) or traditional IRA penalty free before the age of 59.5. This is why it's prudent to contribute to a Roth IRA with post-tax dollars if your company offers one. The catch is your income must be under the IRS mandated limit.
Single filers need a modified adjusted gross income (MAGI) under $161,000 to contribute to a Roth IRA for the 2024 tax year. For 2023, the MAGI limit was $153,000. To contribute the full amount, single filers need a MAGI under $146,000 for 2024. Those with incomes from $146,000 to $160,000 are eligible to make partial contributions. This is the “phase out” income range. Once you make $161,000 or more, you are ineligible to contribute.
If you are married filing jointly, your MAGI must be less than $240,000 to contribute for 2024. The phase out reduction range is from $230,000 to $239,999.
A Roth IRA is great for retirement planning if you are in the 24% federal income tax bracket or lower. It's hard to contribute to a Roth IRA once you are in the 32% or higher federal income tax rate. Remember, you will likely earn less in retirement than while working.
The Roth IRA Strategy For Early Retirement
There are two criteria that should incentivize you to contribute to a Roth IRA. 1) You are in the 24% federal income tax bracket. 2) You plan to retire before the age of 59.5. This is the age when you can withdraw from a 401(k) and IRA penalty free. For 2024, the maximum contribution amount is $7,000. And it's $8,000 for “catch up” if you are over the age of 50.
Every early retiree should do the following:
- Max out their 401(k) and IRA
- Max out their Roth IRA
- Build an after-tax retirement portfolio that spits out passive income
- Negotiate a severance to give you a financial runway instead of quit
Steps 2-4 are critical to sustain an early retiree's lifestyle given 401k and IRA money can't be touched until 59.5
I was able to successfully retire in 2012 at the age of 34. But, I made the mistake of not taking full advantage of the Roth IRA while I had a chance. I scoffed at contributing just $2,000 to a retirement savings account back in 1999. Instead, I just contributed the max to my 401(k) instead.
Historical Roth IRA Contribution Limits
The IRA maximum contribution limits have increased over time. They started in 1975 with a $1,500 limit from 1975-1981. Then it rose to $2,000 from 1982-2001 and $3,000 for 2002-2004. During 2005-2006, the limit was $4,000 and then $5,000 from 2008-2012. It rose by $500 to $5,500 from 2013-2018, $6,000 for 2019-2022, and $6,500 for 2023.
Now in 2024, the limit is $7,000 for those aged 49 and below. And it's up to $8,000 for those 50 and older.
Roth contributions can be withdrawn without penalty (again, not the gains, only your original cost basis). Thus, Roth accounts essentially serve as an added contingency or emergency fund.
Income-Tax and Penalty Free Roth IRA Withdrawal
It's important to clarify further when you can withdraw from a Roth IRA without penalty.
1) The first requirement is that the withdrawal must be taken five years or more after the account was opened. The IRS counts the five years from the first day of the tax year in which you make your first Roth contribution. In other words, if you open an account on Dec 1, 2024, the IRS starts the clock from January 1, 2024.
2) If you satisfy the five-year time requirement, the IRS says distributions qualify to be both income-tax and penalty free if:
- the money is used to buy, build or rebuild a first home, up to a $10,000 maximum that is spent within 120 days of the withdrawal
- the money is withdrawn because you suffered a disability
- the money is distributed to your beneficiaries or to your estate after you die
When a withdrawal fits these requirements, it is called a “qualified distribution.”
Penalty Free: Higher Education and Medical
Certain other withdrawals still require you to pay income tax. But the IRS won’t punish you with an additional 10 percent early withdrawal penalty. The most common reason is for higher education expenses.
You don’t have to pay the penalty if the withdrawal is for less than or equal to the amount you pay that year for tuition, books, room and board, etc.
Some types of unreimbursed medical expenses also qualify. It's always best to check with the IRS website for more information.
Roth IRA Is Just One Strategy For Early Retirees
Since leaving my job in 2012, I've been able to keep all my retirement funds intact earning compounded returns. In other words, not one dollar has been withdrawn from my retirement funds to pay for my lifestyle. Please note there are disadvantages to a Roth IRA as well.
As an early retiree who has been aggressively saving all these years, drawing down principal feels like a terrible sin.
My severance package could have paid for 5 years of living expenses. But, I invested all of it in the market every time any deferred cash or stock compensation came due. Meanwhile, I invested all of my after-tax passive income as well.
The key for staying retired was really finding something I loved to do, which is to write on Financial Samurai. I started this site in 2009 during the middle of the financial crisis. I was scared of losing all my money and wanted a way to cope and help others.
Instead of smoking or drinking, I found writing to be therapeutic. The more I wrote, the more this site grew. After I left work in 2012, I wrote even more. And now, this site earns a nice semi-passive income stream through advertisement revenue. Maybe you want to start your own site one day and stay connected to like-minded individuals.
Reduced Costs In Retirement
In retirement, all you really need is to make a fraction of what you were making when working full-time to live a comfortable life. Once you've got your housing costs and healthcare costs squared away, retirement life is cheaper than you think.
Use a Roth IRA to help diversify your retirement needs. Hopefully, you'll never have to touch your Roth IRA, traditional IRA, and 401(k) in retirement because you're too busy living within your means. But in case of an emergency, a Roth IRA can certainly help provide you that buffer you're looking for.
Save aggressively and invest often. You will not regret your decision to delay gratification in exchange for financial freedom!
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