What Is a Roth IRA?



A Roth IRA is a qualified individual retirement account that allows you to grow investments tax-free. You contribute money you’ve already paid taxes on, but that means you don’t owe taxes on qualified withdrawals. That’s the reverse of a traditional IRA or 401(k), in which you don’t pay taxes on money you contribute but do owe income tax on any withdrawals. There’s also no required distribution from your Roth IRA, unlike a traditional IRA or 401(k).

Although a Roth IRA doesn’t offer the advantage of letting you reduce your taxable income right now, it can be used in combination with your 401(k) or traditional IRA in retirement to help you cover expenses while keeping your taxable income low.

How Does a Roth IRA Work?

Roth IRAs function exactly like traditional IRAs with some key exceptions. To make an informed retirement planning decision, you should understand those exceptions and why they matter. Here are the details on Roth IRA contribution and distribution tax implications:

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Benefits of a Roth IRA

Having a Roth IRA offers several major benefits:

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Roth IRA Contribution Limits

One big difference between a Roth IRA and a 401(k) is the maximum amount you are allowed to contribute per year. For tax year 2018, Roth IRA limits are $5,500 or $6,500 if you are 50 or older. However, that’s increasing to $6,000 and $7,000 for the 2019 tax year — i.e. the tax return you’ll file in 2020. Certain exceptions might apply based on your tax filing status and adjusted gross income.

Income Eligibility Test for Roth IRAs

You must not exceed the Roth IRA income limits established by the IRS, which are based on your adjusted gross income and are the same for both Roth and traditional IRAs. For 2018, the requirements for single filers and married couples are:

Income Eligibility for Roth IRAs
Filing Status Adjusted Gross Income (AGI) Allowable Contribution
Married Filing Jointly or Qualified Widower Up to $193,000 Up to the annual limit
$193,000 to $203,000 A reduced amount
Over $203,000 Zero
Married Filing Separately and you lived with your spouse at any time during the tax year Under $10,000 A reduced amount
Over $10,000 Zero
Single, Head of Household or Married Filing Separately Under $122,000 Up to the annual limit
$122,000 to $137,000 A reduced amount
Over $137,000 Zero

Figuring out amounts for incomes between $122,000 and $137,000 for singles or $193,000 and $203,000 is a little complicated. Here’s how to calculate the reduced amounts for those filing situations:

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  1. Start with your AGI and subtract the threshold for normal contributions ($122,000 for single filers or $193,000 for married filing jointly).
  2. Divide the result by $15,000 or $10,000 if you’re married filing jointly.
  3. Multiply the result by the maximum annual contribution.
  4. Your highest allowable contribution is the normal annual limit minus the number you got in step 3.

For example, if your income is $125,000 and you are a single filer:

1. $125,000 – $122,000 = $3,000
2. $3,000 ÷ $15,000 = 0.2
3. 0.2 x $5,500 = $1,100
4. $5,500 – $1,100 = $4,400 = highest allowable contribution

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Roth IRA Distribution Rules

The required minimum distribution rule requires you to begin drawing down your 401(k) or traditional IRA account once you reach 70.5. This rule can have important tax implications as you’ll be forced to either take those distributions as taxable income or pay a steep penalty. Roth IRAs, however, are exempt from this rule. You can continue to make contributions to your Roth IRA indefinitely and there are no mandatory distribution requirements up until your death.

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Roth IRA Early Withdrawal Penalties

Unless an exception applies, any distributions you take from a 401(k) or traditional IRA before you’re 59.5 are subject to a 10 percent early withdrawal tax. The same rules apply to your Roth IRA, but there are certain conditions in which you can take an early withdrawal without the additional penalty, including but not limited to:

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Comparing Retirement Savings Plans

A 401(k) differs from a Roth IRA or traditional IRA in their maximum allowable contribution amounts — with a much higher cap on a 401(k) than an IRA. Consult this chart which shows the higher contribution amounts allowable with a 401(k) for the 2018 tax year:

Maximum Retirement Account Contributions for 2018
Roth IRA 401(k)
Maximum Contribution up to Age 49 $5,500 $18,500
Maximum Contribution Age 50 and Older $6,500 $24,500

However, those limits are rising for the 2019 tax year.

Maximum Retirement Account Contributions for 2019
Roth and Traditional IRA 401(k)
Maximum Contribution up to Age 49 $6,000 $19,000
Maximum Contribution Age 50 and Older $7,000 $25,000

Which Retirement Plan Is Better for You? Roth vs.Traditional IRA

You can open a Roth IRA at any bank and at most other financial institutions, such as investment brokerage firms. Some firms might require an initial minimum opening deposit to fund your account, and some might not. Do your research to find the best place to open your Roth IRA.

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John Kinsellagh contributed to the reporting for this article.