What Is a Roth IRA?
Roth IRAs allow you to contribute and grow your money tax-free. Here’s how they work and why they can be extremely useful for retirement.
Sean Canonica
Senior Finance Writer
Sean is a finance writer and content strategist for ComparisonAdviser. He has over three years of experience writing about various topics, such as insurance, financial advisors, and investing. Additionally, he is a co-founder and the CEO of RateSonic, an online insurance resource. Sean values helping readers understand difficult topics by creating easy-to-read and thorough content.
View ProfileWhen you plan for retirement, you’ll have plenty of financial tools to choose from to help you reach your goals. One you might hear about from peers and advisors alike is the Roth IRA. This is a tax-advantaged savings account that you can contribute to and invest with to build wealth for your later years.
The major benefit of a Roth IRA is that you won’t pay taxes on distributions. This means, once you’re ready to withdraw funds, you can do so without owing anything to the government. And, yes, that means any profit you’ve made as well! However, you must wait until you’re 59.5 years old to take any money out.
For most Americans, having a Roth account is highly beneficial. While it may not be able to serve as your only vehicle for retirement, it can be a key part of any retirement plan. In this article, you’ll learn more about what they are and how they work. This includes a look at the benefits and disadvantages. Additionally, we’ll teach you about eligibility requirements and how to open an account.
Definition and How It Works
The term, Roth IRA, refers to an individual retirement account (IRA) that was first established in 1997 after being proposed in 1989 by Senators William Roth and Bob Packwood. It allows you to contribute to the account money that’s already been taxed. Then, you’ll be able to invest in various types of securities, such as:
Once you reach the age of 59.5, you’ll be able to withdraw funds tax-free. Taking money out beforehand incurs a 10% penalty. The tax benefit is especially useful if you find yourself in a higher bracket later once you retire.
Difference Between a Traditional and Roth IRA
You may have also heard of a traditional IRA. This is a similar type of tax-advantaged savings account. However, it has significant differences from a Roth. For example, with the former, your withdrawals will be taxed, but your contributions are deductible. Also, it requires you to make distributions at 73, or else you’ll have to pay a fee.
Pros and Cons
As mentioned, Roth IRAs are highly useful retirement tools. They come with a whole swath of benefits that you can use to your advantage, including the ability to withdraw funds tax-free. However, as with other retirement savings accounts, there are some limitations to think about. Below, we’ll break down the key advantages and disadvantages you should consider:
Pros
- You may withdraw money tax-free. Contributions and earnings from your investments/interest may be withdrawn tax-free.
- No required distributions. Unlike a traditional IRA, Roths don’t require you to take money out at a certain age. You may leave funds in as long as you wish.
- No age limit for contributions. You may contribute funds at any age as long as you meet the income eligibility requirements.
- Beneficiaries won’t have to pay taxes. If you pass your account onto beneficiaries after your death, they also won’t have to pay federal income tax on withdrawals.
- Plenty of investment options. Roth IRAs allow you a wide range of investment options, such as stocks, bonds, mutual funds, and REITs. This differs from other retirement accounts, like 401(k)s, which may not have the same flexibility.
Cons
- Can’t withdraw penalty-free until you’re 59.5 years old. You must wait until you’re near retirement age to take earnings out. Otherwise, you’ll be subject to a 10% fee. However, you may withdraw contributions penalty-free if you need money right away.
- Contributions are limited. You can only contribute a certain amount every year. And, depending on your income, how much you can deposit may be limited even more.
- Contributions aren’t tax-deductible. A traditional IRA lets you use contributions as a deduction for your taxes. Roth IRAs, on the other hand, don’t let you do this.
Eligibility Requirements
With a Roth IRA, there are income eligibility requirements to consider. How much money you make per year informs the amount you’ll be able to contribute to your account. The higher your salary (your spouse’s counts too), the less you can deposit.
Anyone making under $146,000, or $230,000 if filing taxes jointly, can contribute up to $7,000 (or $8,000 if you’re over 50). The table below displays the income-based contributions limits for 2024:
| Filing Status | Modified Adjusted Gross Income (MAGI) | Contribution Limit |
|---|---|---|
| Married filing jointly | Less than $230,000 | $7,000 (or $8,000 if you’re over 50) |
| Married filing jointly | Greater than or equal to $230,000, less than $240,000 | Reduced amount |
| Married filing jointly | Greater than or equal to $240,000 | N/A |
| Married filing separately | Less than $10,000 | Reduced amount |
| Married filing separately | Greater than or equal to $10,000 | N/A |
| Single, head of household, or didn’t live with spouse during the year | Less than $146,000 | $7,000 (or $8,000 if you’re over 50) |
| Single, head of household, or didn’t live with spouse during the year | Greater than or equal to $146,000, less than $161,000 | Reduced amount |
| Single, head of household, or didn’t live with spouse during the year | Greater than or equal to $161,000 | N/A |
As you might have noticed in the table, you can only deposit up to $6,500 annually if you’re eligible for a full contribution. However, if you’re over the age of 50, you can contribute $7,500 each year.
How to Open an Account
Roth IRAs are fairly simple to set up. First, you’ll need to select a financial institution to open an account with, such as Fidelity or Vanguard. Then, you must apply for an account by entering personal info, like your social security number and date of birth. Finally, you’ll need to fund the account according to your contribution limits.
Is a Roth IRA Right For Me?
A Roth IRA can be a very useful tool to save for retirement, but should you have one? For most Americans, it’s a smart choice if they meet the eligibility requirements and are able to contribute.
To know if a Roth IRA fits into your retirement plans, it’d be wise to consult with a financial advisor, such as a certified financial planner (CFP). They’ll be able to take your current situation into account, then determine whether such an account fits into a coherent plan. You can find someone by using a free matching tool, which will connect you with up to three vetted advisors in your area.
Frequently Asked Questions
When can I withdraw money from my Roth IRA?
You’re eligible to take funds out of your account once you reach the age of 59.5. At this time, you won’t incur any penalties or taxes. However, you can always withdraw contributions to your Roth IRA at any age without having to pay a fee.
Also, keep in mind that you may keep funds in your account as long as you want. This differs from a traditional IRA, which forces you to make distributions at age 73.
How much can I contribute each year?
The exact amount depends on your age and income (see the table above for more specifics). However, you can generally contribute up to $7,000 annually. Or, if you’re 70 years old, you can deposit $8,000.
Are contributions tax deductible?
No, contributions aren’t able to be used as deductions on your taxes. This is a significant difference from the traditional IRA, which allows you to do so. Keep in mind that, while you can’t deduct deposits, you’ll be able to grow and withdraw money later tax-free. So, if you find yourself in a higher tax bracket in retirement, you’ll end up saving a lot.
Can you have a 401(k) and a Roth IRA?
Yes, you’re able to have both a 401(k) and Roth IRA at the same time. In fact, it may be the smart choice to contribute to both. Often, having only one retirement account won’t be enough to live comfortably. Your financial advisor can help you chart a retirement plan that maximizes your wealth and income using accounts such as these.