What is a Roth IRA? How Roth IRAs work, contribution limits and who can open one
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A Roth IRA is one of the most popular ways for individuals to save for retirement, and it offers some big tax advantages, including the ability to withdraw your money tax-free in retirement. In fact, many experts consider the Roth IRA the best retirement plan available.
Here’s how the Roth IRA works, what it offers and how it compares to a traditional IRA. If you already know you want a Roth IRA, it’s tremendously easy to open one and get started. Or you can skip right to the best brokers for Roth IRAs
The Roth IRA offers big tax advantages
Like its cousin the traditional IRA, a Roth IRA offers individuals an opportunity to save for retirement on a tax-advantaged basis. With a Roth IRA, you can deposit after-tax money, grow that money, and then take it out at retirement (age 59 ½ or older) tax-free forever. The whole “tax-free forever” part? That’s what turns heads, but the Roth IRA offers other perks.
Its tax-free nature makes the Roth IRA especially attractive if the account is likely to be passed down, since it can save the inheritors significant taxes. Plus, you’re never too old to invest in a Roth IRA, so you can stash money there your whole life, as long as you qualify (see below).
The Roth IRA is flexible. You can withdraw contributions any time tax-free (since you’ve already paid taxes on them), and you can use the money for any reason. But experts warn against this.
If you take out earnings early, though, you can be hit with taxes on the gains and a bonus penalty of 10 percent on the earnings. However, certain uses — such as for qualified educational expenses — can help you avoid the bonus penalty, though not the income taxes.
On top of all this, the Roth IRA allows you to invest in potentially high-return investments such as stocks and stock funds, where you could earn much more than in a traditional bank account.
What are the other rules for the Roth IRA?
You can withdraw any contributions and earnings tax-free at retirement, with only one stipulation: five years must have elapsed since your first contribution to a Roth IRA, and the clock starts on January 1 of the year you made it. The five-year rule is important to remember, and it means that you need to open a Roth IRA earlier and plan a bit ahead.
In 2024, you’re allowed to contribute up to $7,000 annually to your Roth IRA. If you’re 50 years of age or older, you can make an additional catch-up contribution of $1,000 each year.
The Roth IRA is also a great rollover option if you have a Roth 401(k) as a retirement account. You can roll the money from the employer-sponsored account to a Roth IRA held in a brokerage account, for example, and be able to invest in whatever you want, not just the funds available in the 401(k). Money in a Roth 401(k) should move to a Roth IRA without creating tax liabilities, but any employer match held in a traditional 401(k) will be subject to tax if rolled to a Roth IRA.
Who can open a Roth IRA?
In general, anyone with earned income (here’s what counts) in a given year can contribute to a Roth IRA. You can add up to the lesser of the maximum annual contribution or your earnings.
There is an exception, however, and it’s called the spousal IRA. If your spouse earns money, you and your spouse are each able to contribute up to the maximum contribution or your total annual income, whichever is less.
In addition, the Roth IRA places income limits on who can contribute directly, though you have ways around that. The limits for 2024 include:
- If you’re an individual filer, you can contribute the maximum amount if your modified adjusted gross income is under $146,000. The limit is reduced and phases out up to income of $161,000.
- If you’re married filing jointly, you can contribute the maximum amount if your modified adjusted gross income stays below $230,000. The limit is reduced and phases out up to income of $240,000.
If you make above those amounts, you can still open a Roth IRA, but the route is a bit more roundabout using what’s called a backdoor Roth IRA. The short of it is that you can open a traditional IRA and then convert the account to a Roth, but here are the full details.
Roth IRA vs. traditional IRA
The other main kind of individual retirement account is the traditional IRA, and that can be a valuable savings vehicle for retirement, too. In contrast to the Roth IRA, the traditional IRA allows you to make contributions on a pre-tax basis, meaning you get a tax break this year on what you put in. At retirement (age 59 ½ or older), you’ll pay regular taxes on any withdrawals.
The traditional IRA does have income limits, so that if you make too much you won’t be able to use pre-tax money to do so. But you can convert the account to a Roth IRA and get the Roth’s tax advantage that way. The traditional IRA has required minimum distributions in retirement.
Those are a few of the key differences between the two IRAs – here’s the complete rundown.
Bottom line
Because of its ability to shield taxes on earnings forever, the Roth IRA is one of the most popular retirement savings options. But don’t overlook the Roth IRA’s other valuable features, including no required minimum distributions and attractive estate-planning benefits.