Roth IRA Demystified – Answering The Most Common Questions On The Account

Roth IRA questions – I’m answering questions I have been asked lately on Roth IRA accounts.

Roth IRA Accounts Questions & answers

I plan to update this post regularly, so please feel free to send whatever questions you have on this account, and I’m happy to keep updating this post.

In Summary – These Are Some Of The Questions I Tackle

      • Roth IRA eligibility

      • Whether one can open the account if on a work visa or not.

      • If international students can open the account or not and whether they should. 

      • The types of income that can be used  to fund the Roth

      • The multiple 5-year rules that apply to the Roth IRA account.

      • How to avoid the penalty of taking money out before it’s time. 

Posts On Roth IRA On Elgon Financial Advisors Blog

I have written a couple of posts on Roth IRAs in the past, which I’ll link to for some of my answers.

Roth IRAs are one of the best tools for teaching kids financial literacy.

This first post explains how to make use of this opportunity. As soon as your teens get their driver’s licenses, and start working outside the home, introduce them to the investing world via the Roth IRA.

Roth IRA, The Best Money Decision For Your Teen.

I followed my own advice. In this post, I detail the steps I took to help my teen open her first Roth IRA account.

How to Open a Teen Roth IRA Account in 6 Steps

I have also seen folks make serious mistakes with Roth IRA accounts – in this post, I detail the top 4 mistakes I see. In addition, I tell you exactly how to fix the issues.

The Top Roth IRA Mistakes To Avoid and How to Fix Them

On to more Roth IRA questions and answers.

Can I Save Into The Account If I’m On A Work Visa Like H-1B?

This Roth IRA question comes from foreign nationals working in the US on work visas, like H-1B, 0-1, TN, L-1, O-1, etc.

The simple answer is yes you can save into a Roth IRA account, using your US–earned income.

It means that you need to be employed by somebody or some entity, that’s actually paying you.

The max you can contribute for 2023 is $6,500 ($7500 if 50 or older).

In case you earned less than this, you can’t top it up with gifts or other money.

If married, and your spouse did not work, you can make a spousal contribution for them, as long as you have the income to cover both accounts.

If you make a mistake with the contributions (do more or contribute when not allowed) – you are likely to owe a 6% penalty, until you fix it – see the above post for how to fix this mistake.

If On A Work Visa, Should You Contribute To A Roth IRA?

The answer to this Roth IRA question is complicated and it depends on your specific situation. It’s also one that’s best tackled with the help of a tax or finance professional.

Roth IRAs can be used for other things outside retirement – a later question.

If planning to use them for that purpose, then yes it makes sense to invest in the account.

Also, if planning on taking the earnings out at 59.5, while in the US, it probably makes sense to use the account.

Check what country you are going to be in when you withdraw the money, as well as your US tax residency status.

Generally, if the country you are moving to has a tax treaty with the US and recognizes the tax-free nature of the account, then a Roth IRA can be a good thing to have.

Otherwise, dig deeper into how your home country will likely treat the account before deciding on this. And again, it depends on when you are likely to move. Do the math as well.

Roth IRA For International Students On Student Visa Like F-1?

One of the top questions I get from international students on different student visas is whether they can open a ROTH IRA or not

The simple answer is yes. You can start a Roth IRA  as long as you have US-earned income – see the details in the other visa question above. 

Keep in mind that as a student on an F-1 visa, you are most likely still filing taxes as a US tax nonresident.

So unless your status is going to change, you may have to contend with being a US nonresident with US assets at some point. 

Does Rental Income Count Towards Earned Income For The Roth?

This is one of the most common Roth IRA questions that trips a lot of people.

No – it does not. Rental income and other types of passive income don’t count as earned income. Other incomes that DON’T count are

    • Dividends,
    • Capital gains from investments or the sale of assets like a house,
    • Interest
    • Social security etc.

US-earned income is typically what you get if employed by somebody else. Examples are.

    • W-2 income
    • Bonus
    • Commissions
    • Tips
    • 1099 income (self-employment)
    • Business income etc.

What Are The 3 Roth IRA 5-Year Rules?

The 5-year deal is rather confusing and hence one of the top Roth IRA questions, I see time and again. There are 3 variations of this. I’m going to address each of them separately.

The Roth IRA money contribution goes in after taxes, so this can be taken out anytime.

Note that we are talking about a pure clean new Roth IRA account, not a converted account, a 401k Roth, or the mega-back door Roth account.

Rule 1:  5-Year Rule for Roth IRA Withdrawals

At 59.5, you can withdraw both your original contribution and the earnings as long as the account has been open for at least 5 years.

One thing to remember is that the 5-year holding period applies to all Roth accounts you have, and not necessarily to the one you are withdrawing from.

This means that if you have two Roth IRAs, one is 4 years old, one is 5+ years old, and you are 59.5, you can withdraw from the 4-year-old Roth IRA with no penalties.

Rule 2: 5-Year Roth IRA Rule On Principal Distribution

If you convert a traditional IRA or a 401k to a Roth IRA, you cannot take a distribution without a penalty before 5 years are over. If you are already 59.5, there is no 10% penalty but you pay taxes on withdrawals, above what you contributed.

The calculation uses tax years, but the conversion should have happened by Dec 31st. So, for example, if you convert an IRA to a Roth IRA on June 1, 2023, the calendar year starts on Jan 1, 2023.

Each conversion is treated as a separate transaction so keep records.

Rule 3:5-Year Roth IRA Rule For Beneficiaries

If you inherit a Roth IRA, you have to take the Required Minimum Distributions (RMDs), from the account.

Unfortunately, if the deceased had not held the Roth IRA for 5 years, you’ll have to pay a tax on the earnings, but not the 10% penalty.

When Can You Take Money Out Of a Roth IRA Without A Penalty?

Typically, withdrawals can cost you a 10% penalty and taxes on the earnings. There are a couple of situations that avoid this situation completely.

You can take out your contributions at any point without any penalties.

For example, if you contributed to a Roth IRA this year, and in a couple of years it’s grown to $8,000, you can take out your original contribution of $6,500, leaving $1,500 with no penalties.

If you’ve held your Roth IRA for 5 years, you can withdraw the earnings at 59.5 with no penalties and no taxes.

Avoiding the 10% Penalty and Possibly Taxes On The Earnings

The following withdrawals will avoid the penalty, but you still have to pay income tax on the earnings. I’ve excluded some of the ones addressed in other sections above, especially with the 5-year rules.

    • Withdraw $10,000 for your first home – it’s a one-time deal (If held for 5 years, then no income tax).
    • Withdraw $5,000 the year after you have a baby (birth or adoption).
    • Use the money to pay qualified education expenses.
    • For medical expenses or health insurance premiums if unemployed.
    • Due to disability (If held for 5 years, then no income tax).
    • To pay an IRS levy – a legal seizure of your property to pay debt.

 The Roth IRA account is a great tool in your saving journey – just ensure you understand the ins and outs of the account. Use it appropriately.

What other Roth IRA questions do you have? Please share them with me and I’m happy to update the post with the answers.

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Disclaimer:  This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for the purchase or sale of any security, investment advisory services, or legal advice. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Jane Mepham and all rights are reserved. Read the full disclaimer here.

Jane Mepham, CFP® is a Fee-Only financial planner who loves simplifying the complexities of the U.S. financial system for immigrants and foreign nationals on work visas and those in tech. She’ll work with you to map out a personal strategy that addresses all areas of your financial life while avoiding key financial mistakes that could derail your American dream.