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.
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?
With a Roth account, you contribute money that you’ve already paid taxes on — that is, money from your paycheck after factors such as payroll and Social Security taxes have been withheld — and your money grows tax-free. You can invest the funds in certificates of deposit, stocks, bonds, mutual funds and other vehicles.
Here’s a breakdown of how it works.
How To Get Started
You can start a Roth IRA with a bank, credit union, life insurance company or investment company. To open an account, choose an institution to open your Roth IRA with.
The best place to open a Roth IRA is one that’s convenient for you. For example, some robo-advisors allow you to open a Roth IRA and make automatic investments, while others offer personalized advice from a financial advisor.
When you open your Roth IRA, you’ll need to provide personal information like your name, date of birth, Social Security number and address. Next, you’ll choose your investments according to your risk tolerance. After that, you start funding.
How To Fund a Roth IRA
There’s no across-the-board minimum you need to start planning for retirement with an IRA. The institution you choose may have a minimum, though.
There are contribution limits, however. For 2022, the maximum you can contribute is $6,000 — $7,000 if you’re age 50 or older — in total across all your IRAs. Depending on your income, your maximum Roth IRA contribution limit may be lower.
Unlike other retirement accounts, your contributions aren’t tax deductible. The good news is that as long as you meet the requirements, you won’t need to pay taxes when you withdraw the funds.
Here’s a look at a few options for funding your account.
- Regular Contributions: A contribution is adding money to your IRA. Setting up regular contributions is one of the best ways to fund an IRA. Choose a schedule that works best for you: weekly, biweekly or monthly.
- You can also make occasional contributions. For example, you might choose to stash your tax return in a Roth IRA.
- Spousal IRA Contributions: Spouses can make contributions to either spouse’s Roth IRA. Your total contribution can’t be more than your joint taxable income or two times the annual contribution limit.
- Transfers: Also known as a rollover, you can transfer funds from another retirement plan into a Roth IRA. For example, if you leave an employer, you can roll over your 401(k) into a Roth IRA.
- There’s a catch, though. Since a 401(k) is funded with pretax dollars, you’ll owe taxes on the rollover, which could be substantial.
How To Withdraw Funds
To withdraw funds from your Roth IRA, contact the institution holding your IRA and ask for a distribution. You can withdraw what you contributed to your Roth IRA at any time.
If you also want to withdraw any interest you’ve earned, and you want that withdrawal to be tax- and penalty-free, you’ll need to follow a few guidelines.
- Your withdrawal must be made five years after you contributed the funds.
- You must be a minimum age of 59 ½, with the following exceptions:
- You’re disabled.
- The withdrawal is going to a beneficiary after your passing.
- You’re buying your first home.
- You’re paying for higher education expenses for yourself, a spouse, children or grandchildren.
If you withdraw funds before age 59 ½ and don’t meet one of the exceptions, you’ll need to pay taxes and an early withdrawal penalty of 10% on any earnings.
It’s best to avoid nonqualified withdrawals of your earnings, if possible, so your funds keep growing until retirement. That said, if you need to dip into a retirement account, a Roth IRA is a better choice than other retirement accounts.
Who Is Eligible for a Roth IRA?
You can contribute to a Roth IRA as long as you have earned income, which is money from some form of employment. You also have to be below certain income limits. Here are the income limits for 2022 contributions:
| Filing Status | Adjusted Gross Income | Allowable Contribution |
|---|---|---|
| Married Filing Jointly or Qualified Widow(er) | Less than $204,000 | Up to $6,000 — $7,000 if age 50 or older |
| $204,000-$213,999 | Reduced amount | |
| $214,000 or more | Zero | |
| Married Filing Separately and you lived with your spouse at any time during the tax year | Under $10,000 | Reduced amount |
| $10,000 or more | Zero | |
| Single, Head of Household or Married Filing Separately | Under $129,000 | Up to $6,000 — $7,000 if age 50 or older |
| $129,000-$139,999 | Reduced amount | |
| $144,000 or more | Zero |
For example, say you made $55,000 in 2021 in adjusted gross income. You would be eligible to contribute up to $6,000 to your Roth IRA retirement fund. If you are 50 or older, you can contribute up to $7,000.
How To Calculate a Reduced Roth IRA Contribution
- Start with your modified adjusted gross income. Subtract one of the following amounts:
- $204,000 if married filing jointly or a qualifying widow(er)
- $0 if you’re married filing separately and you lived with your spouse during the year
- $129,000 for any other filing status
- Divide the total by $15,000 or $10,000 if you’re married filing jointly, a qualifying widow(er), or married filing separately and you lived with your spouse during the year.
- Multiply the result by the maximum contribution — $6,000 for age 49 and younger, $7,000 for age 50 and older.
- Subtract the result of step 4 from the maximum contribution — $6,000 or $7,000.
Any age is a good age to start a Roth IRA. As with any retirement account, the sooner you start one, the better. You could start a Roth IRA at 18 and contribute until you stop working. There’s no age when a Roth IRA doesn’t make sense.
What Are the Advantages of a Roth IRA?
A Roth IRA offers several benefits, including:
- Easy withdrawals. Once you reach age 59 ½, you can withdraw funds whenever you need them without worrying about tax consequences.
- No withdrawal requirement. With other retirement plans, you have to take money out every year starting at age 72, which makes sense since the funds haven’t been taxed. You can leave the money in a Roth IRA alone until you need it.
- Double dipping. You can contribute to a Roth IRA in addition to a 401(k), which allows you to lower your pretax income and take advantage of employer matches while building an additional nest egg.
- Flexibility. You can contribute to a Roth IRA at any time and in any amounts, up to your maximum allowed contribution.
What Are the Disadvantages of a Roth IRA?
The main disadvantage of a Roth IRA is that you can’t deduct it on your taxes. You’re paying taxes on your contributions now so you don’t have to deal with taxes later. Plus, the amount you contribute is limited to just $6,000 to $7,000 per year, at most.
Another disadvantage of a Roth IRA is the potential to lose money. That’s true of many investment vehicles, though. Your personal preferences and risk tolerance should drive your investment choices and your choice of IRA provider.
As you get closer to retirement, you can shift portions of your Roth IRA into low- or no-risk options like CDs.
Roth IRA vs. Traditional IRA
With a traditional IRA, your contributions are tax deductible. Here’s how it stacks up against a Roth IRA.
| Roth IRA | Traditional IRA | |
|---|---|---|
| Maximum Contributions | $6,000 or $7,000 if you’re age 50 or older | $6,000 or $7,000 if you’re age 50 or older |
| Income Limits | Your income must be below certain amounts to contribute. | No income limit to contribute, but you must be below certain limits to deduct your contributions. |
| Early Withdrawal Penalty | No early withdrawal penalty for contributions, 10% early withdrawal penalty for earnings. | Early withdrawals are taxable and subject to a 10% penalty. |
| Required Minimum Distributions | None | You must start taking minimum required distributions at age 72. |
What Is a Backdoor Roth?
If you have too much income to qualify for a Roth, you can convert a 401(k) or traditional IRA into a Roth. This has tax implications, as you’re moving from a pretax vehicle to an after-tax one, but it might be worth it to have the flexibility offered by a Roth.
Takeaway
A Roth IRA can be a smart, worthwhile vehicle to save for retirement. It’s easy to manage, and you don’t have to report your contributions on your tax return.
Both your contributions and your withdrawals are flexible, and you don’t have to worry about taxes when you withdraw the funds.
Choose investment vehicles that fit your risk tolerance, contribute as much as you can and let it grow. Every dollar you put away helps, and now’s a great time to get started.
Cynthia Bowman contributed to the reporting for this article.
This article has been updated with additional reporting since its original publication.