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11 Mistakes to Avoid with Your Roth IRA

Don’t lose tax-free benefits by contributing too much or making other errors

Individual retirement accounts (IRAs) are a great option for anyone who wants to save up for retirement, whether you choose a traditional or a Roth version. You may think that the only thing that you need to know about a Roth IRA is that your contributions are limited to $6,000 if you are under age 50 and $7,000 if you are 50 or older. Well, it’s a little more complicated than that.

Here are 11 common errors that people with Roth IRAs are likely to make, and a few suggestions on how to avoid those mistakes.

Key Takeaways

  • Contributing to a Roth individual retirement account (Roth IRA) may seem like a great idea, but there are complications that you must avoid.
  • You can’t contribute more to a Roth IRA than you’ve earned in income, and there are income limits for contributions as well.
  • Exceeding the Roth IRA contribution limit will result in a yearly 6% penalty on the excess until it is removed from the account.
  • IRA rollovers also must be done carefully and within 60 days to avoid taxes and penalties.
  • Not naming beneficiaries and not taking distributions if you inherit a Roth IRA are common mistakes as well.

Roth vs. Traditional IRA

You’ll probably want a quick refresher on the key differences between a Roth IRA and a traditional IRA. Contributions to a Roth IRA are not tax deductible when you make them. But the distributions can be tax free. This untaxed status for distributions applies to both the original contributions and the gains on them, assuming you’re over age 59½ when you withdraw the funds and the account is at least five years old.

Contributions to a traditional IRA, on the other hand, are tax deductible. But when it comes time to withdraw the funds, you’ll have to pay taxes on them at whatever your income tax rate is then. What’s more, you have to take required minimum distributions (RMDs) on traditional IRAs by April 1 of the year after you reach the age of 72. Roth IRAs are not subject to RMD requirements until the death of the account holder.

If you don’t need the money, you can leave the account to your heirs. But in 2020, the Internal Revenue Service (IRS) changed the mandatory distribution rules for heirs of IRAs. All funds in the beneficiary’s account must be distributed by the end of the 10th year after the death of the original IRA owner. There are exceptions, such as for spouses, minor children, disabled or chronically ill people, and those who are not more than 10 years younger than the IRA owner.

Below are the mistakes to avoid.

1. Not Earning Enough to Contribute

You cannot contribute more to a Roth IRA than you received in earned income for the year. This income can come from wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services.

You can also count earnings from:

  • Commissions
  • Self-employment income
  • Nontaxable combat pay
  • Military differential pay
  • Taxable alimony
  • Separate maintenance payments

You can contribute to a Roth up to allowable limits for both yourself and your spouse as long as you file your taxes jointly and one of you makes enough eligible income to fund the contributions.

So-called unearned income, such as dividends, interest, or capital gains, are not allowed as part of your Roth contribution. Rental income or income received from a partnership in which you do not play an active role is also considered unearned income.

2. Earning Too Much to Contribute

You can earn too much overall to contribute to a Roth IRA. Whether you’re eligible is determined by your modified adjusted gross income (MAGI). When calculating your MAGI, your income is reduced by certain deductions, such as contributions to a traditional IRA, student loan interest, tuition and fees, and foreign earnings.

The income limits for Roth IRAs are adjusted periodically by the IRS. People who are married filing jointly or a qualifying widow(er) must make less than $198,000 in 2021 ($204,000 in 2022) to be able to make the maximum contribution. If you earn $198,000 to $208,000 in 2021 ($204,000 to $214,000 in 2022), you may be able to contribute some money, but the amount is reduced. With earnings above $208,000, no contribution is allowed.

Taxpayers in 2021 who are filing as single, head of household, or married filing separately (who did not live with their spouse at any time during the year) can contribute to a Roth IRA as long as they earn less than $125,000 ($129,000 in 2022). The allowed contribution starts phasing out if they earn $125,000 or more and is eliminated entirely above $140,000 in 2021 ($129,000 to $144,000 in 2022).

What if you’re married and live with your spouse, but file taxes separately? If you earn more than $10,000, you cannot contribute to a Roth IRA at all. If you made less, you might be able to make a reduced contribution. Only those who are completely separated can make a substantial contribution, as delineated above. This amount remains the same for tax year 2022.

3. Not Contributing for Your Spouse

You can’t contribute more to a Roth than you’ve earned in a given year. But there’s an important exception for nonworking spouses, as long as you’re legally married and file a joint return.

Since there’s no such thing as a joint IRA, you may want to consider a spousal IRA. This option allows a nonworking spouse to establish an account and have the working spouse make contributions to it as well as to their own. The working spouse’s income must be enough to cover both contributions. But increasing (and perhaps even doubling) your annual contributions is certainly not the worst idea in the world, and could significantly increase a family’s retirement savings over time.

4. Contributing Too Much

If you have more than one IRA, or your income gets an unexpected boost, you can easily make the mistake of contributing more than the allowable maximum. (Remember, the annual limit of $6,000—or $7,000 including the catch-up provision—is for all your IRAs, not per account.) Exceeding this limit can cost you a 6% penalty on the excess each year until you rectify the mistake.

You can avoid the penalty if you discover the mistake before filing your tax return and take the excess contribution, plus any earnings on it, out of the account. You can actually withdraw some or all of your Roth IRA contributions up to six months after the original due date of the return, but you then must file an amended return. You can also carry over the excess contribution to another tax year, but unless that’s done simultaneously with the correction, it might trigger the penalty.

5. Withdrawing Earnings Too Early

The withdrawal rules for Roth funds can be a tad complicated. You can withdraw the amounts that you contributed at any time, at any age, since those contributions were made with after-tax dollars. But you may owe income tax and a 10% penalty on any earnings that you withdraw.

To enjoy tax- and penalty-free withdrawals on any profits or income that the investments generated, a Roth IRA owner must be 59½ years old and have owned the account for at least five years (the five-year rule). If you pull the money out before those two milestones, you could face some costly consequences.

People under age 59½ can avoid the early withdrawal penalty (although not the applicable taxes) on earnings in limited cases. For instance, you can pull out money to cover the costs of certain education expenses or to pay for a first-time home purchase.

6. Breaking the Rollover Rules

You used to be able to do an IRA rollover only once in a calendar year, but that changed in 2015. The government now restricts you from doing more than one rollover in a 365-day period—even if they occur in two different calendar years.

It’s a rule that you’ll want to pay attention to because too many rollovers can trigger a big tax bill. “Some people can lose their entire IRA because they did two rollovers in a year and didn’t realize it,” according to Ed Slott, author of The New Retirement Savings Time Bomb.

There are some exceptions, as in the case of 60-day rollovers from a traditional IRA into a Roth IRA. Also, the 365-day rule doesn’t apply to the direct transfer of funds between two IRA trustees, which the IRS does not consider a rollover.

7. Rolling Over the Money Yourself

There are two basic ways to roll over funds from one qualified retirement savings account, like a traditional IRA or a 401(k), into a Roth: direct and indirect.

In a direct rollover, your money is transferred from one account to another electronically, or you receive a check made out in the name of the new account and deliver it. With an indirect rollover, you take possession of the money from the old account and deposit it into the new one yourself.

It’s best to avoid the latter move because so many things can go wrong. The most common mistake that people make is missing the 60-day deadline to roll over the money because they used the cash for something else and didn’t have enough to make the full contribution on time. Sometimes, people simply forget.

If you do choose to do it yourself, be meticulous about documenting the rollover in case the IRS questions it. If you can’t prove that you deposited the money in time, you’ll have to pay taxes and penalties on it.

8. Not Considering a Backdoor Roth IRA

If you make too much money to contribute to a Roth, all is not lost. You could instead contribute to a nondeductible IRA, which is available to anyone no matter how much income they earn. (This contribution is made with after-tax dollars, money that has already been taxed.) Then, using a tax strategy called a backdoor Roth IRA, you convert that money into a Roth IRA.

To avoid tax complications, you should quickly convert the nondeductible IRA into a Roth IRA before there are any earnings on the money. Advisors recommend that you deposit the money into a low-interest-earning IRA initially to minimize the chance that it will earn much before you transfer it.

There is also another tax trap that you need to consider: If you have a traditional, deductible IRA or a 401(k) with your employer, you could end up with a hefty tax bill due to the complicated rules on converting other IRAs to Roths. 

You also have the option of converting an existing 401(k) or a traditional IRA to a Roth IRA, using the same backdoor strategy. The advantage of converting is that any earnings after the Roth conversion will no longer be taxable when you withdraw money during retirement. The disadvantage is that you must pay tax based on your current earnings for any money that you convert.

“In general, the longer the time horizon and the higher the likelihood for a higher projected income tax bracket in retirement, the more likely a conversion will work in an investor’s favor,” says Mark Hebner, founder and president of Index Fund Advisors in Irvine, Calif.

Working with a tax or financial advisor on backdoor Roth IRAs and other complicated retirement plan strategies can potentially help you avoid expensive mistakes.

9. Forgetting Your Beneficiary List

Roth IRA owners often forget to list primary and contingent beneficiaries for their account—and that can be a huge mistake. If the account is simply made payable to the IRA owner’s estate, it will have to go through the probate process. In other words, you have more complications, greater delays, and bigger attorney fees.

Once you name beneficiaries, be sure to review them periodically and make any changes or updates. That’s especially important if you and your spouse part ways. A divorce decree by itself won’t prevent a former spouse from getting the assets if they are still listed as a beneficiary.

10. Failing to Withdraw Inherited Roth Money

This is the new 10-year rule that applies to IRA beneficiaries. Unlike the original owner of a Roth IRA and their spouse, other beneficiaries must take distributions. For non-spousal beneficiaries, they must withdraw 100% of the funds within 10 years of the owner’s death.

In the past, RMDs were allowed to be spread out over the beneficiary’s life expectancy, which helped to reduce the tax burden. However, as of 2020, there is no set amount required to be taken in any one year, but all of the money must be withdrawn within the 10-year period following the original owner’s death.

In other words, if you inherit a Roth IRA from someone besides your spouse, you will have to start making withdrawals from it, similar to those of a traditional IRA or 401(k). The good news is that no tax is due on the money if the account is more than five years old.

The tax penalty for not following the RMD rules can be as high as 50% of the amount that was supposed to have been taken out.

One advantage of IRAs over 401(k) plans is that, while most 401(k) plans have limited investment options, IRAs offer the opportunity to put your money in many types of mutual funds, stocks, and other investments.

11. Skipping a Roth Since You Already Have a 401(k)

The original goal of the IRA was to provide an investment vehicle for Americans who didn’t have a retirement plan through an employer. But there’s nothing in the law that prevents you from using both. In fact, financial planners often suggest funding a Roth IRA once you’ve contributed enough to your 401(k) to get your employer’s full matching contribution.

I’m nearing retirement. Should I roll over funds from my other retirement account into a Roth individual retirement account (Roth IRA)?

There is no age limit for contributing to a Roth individual retirement account (Roth IRA). However, you will need to think carefully about your intended use for the funds. If you expect to need the money in the next five years, you will be unable to access the funds from a rollover tax- and penalty-free. The five-year rule is in place for each rollover that you make. If you make one in the current tax year and one next year, you can withdraw the funds from the first in five years and the next in six years.

However, rolling over funds into a Roth IRA has benefits if you do not expect to need the money in your retirement. You will not be subject to required minimum distributions (RMDs), and it allows you to leave more money to your heirs.

What is the Roth IRA contribution limit for 2022?

The contribution limit remains unchanged at $6,000 in 2022 ($7,000 for individuals ages 50 and older).

What are the Roth IRA income phaseout ranges for 2022?

The income phaseout ranges are as follows:

  • Married filing jointly and qualifying widow(er): $204,000 to $214,000
  • Single, head of household, and married filing separately (living separately the entire year): $129,000 to $144,000
  • Married filing separately (not living separately the entire year): $0 to $10,000

The Bottom Line

Having a Roth IRA can provide a bonanza of retirement benefits for both you and your heirs. But pay attention to the rules, so you don’t jeopardize your account’s tax-free status. If you’re looking to start funding an IRA, Investopedia has created a list of the best brokers for IRAs.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
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  2. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2021.”

  3. Internal Revenue Service. “Rollovers of Retirement Plan and IRA Distributions.”

  4. Internal Revenue Service. “Publication 590-B (2020), Distributions from Individual Retirement Arrangements (IRAs).”

  5. Internal Revenue Service. “IRA FAQs — Distributions (Withdrawals).”

  6. Internal Revenue Service. “Retirement Plan and IRA Required Minimum Distributions FAQs.”

  7. Internal Revenue Service. “Topic No. 451 Individual Retirement Arrangements.”

  8. Internal Revenue Service. “IRS Announces 401(k) Limit Increases to $20,500.”

  9. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”

  10. Internal Revenue Service. “Retirement Topics — IRA Contribution Limits.”

  11. Internal Revenue Service. “Instructions for Form 5329 (2021).”

  12. Internal Revenue Service. “Roth IRAs.”

  13. Internal Revenue Service. “Retirement Topics — Exceptions to Tax on Early Distributions.”

  14. Internal Revenue Service. “Retirement Plans FAQs Relating to Waivers of the 60-Day Rollover Requirement.”

  15. Internal Revenue Service. “Rollovers of After-Tax Contributions in Retirement Plans.”

  16. Internal Revenue Service. “IRS Announces Changes to Retirement Plans for 2022.”

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