The Roth IRA explained. This post is a guide for the U.S. tax-exempt individual retirement account. In it we'll explore what a Roth IRA is, who they're for, when to contribute, and where, why, and how to open one.
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What Is a Roth IRA?
A Roth IRA is simply a U.S. retirement savings vehicle by which investors contribute after-tax money, that money grows tax-free, and the withdrawals later in retirement are tax-free.
The Roth IRA was established in 1997 by the Taxpayer Relief Act. IRA explicitly stands for individual retirement account. As the name suggests, this is an account designed to help individuals save for retirement.
Who Can Contribute To a Roth IRA?
Whereas an account like a 401k is tied to your employer, anyone with earned income can open a Roth IRA on their own, provided that income is below the eligibility limit. We'll cover income limits later.
How Does a Roth IRA Work?
The main function of the Roth IRA is that contributions are made with post-tax dollars and then those contributions are allowed to grow tax-free and later be withdrawn in retirement tax-free. In other words, contributions to a Roth IRA are taxed on the front end and not on the back end.
Those contributions must be made in cash and cannot be in the form of securities or property. The IRS limits the amount of annual contributions that can be made to a Roth IRA. We'll go over these contribution limits shortly.
Roth IRAs do not have required minimum distributions, or RMDs, like 401k's and Traditional IRAs do. You can withdraw your contributions penalty-free anytime and you can withdraw earnings anytime after 59.5. This means the Roth IRA has arguably the greatest flexibility of retirement accounts available to Americans.
Since the Roth IRA does not have RMDs, this also makes it a great wealth transfer vehicle because your heirs can withdraw tax-free.
There are also special cases that allow for the early withdrawal of earnings without penalty, including:
- First time home purchase; you can withdraw up to $10,000.
- Higher education expenses
- Medical expenses
- Death
- Disability
- Substantially equal periodic payments
Consult your tax professional if any of those apply to you.
Also note that you can open a Roth IRA in addition to an employer-sponsored plan (ESP) like a 401k.
Roth IRA Investments
You have a wide variety of things you can invest in inside a Roth IRA, including mutual funds, ETFs (Exchange Traded Funds), stocks, bonds, money market funds, certificates of deposit (CDs), cryptocurrency, and more. You can even hold investment real estate in a Roth IRA.
When To Contribute To a Roth IRA
There is no age requirement to open a Roth IRA, provided that person has earned income to cover the contributions. A Roth IRA can be created anytime, but contributions for the current year must be made by the owner's tax deadline, which is typically April 15 of the following year.
For those contributing every year to save for retirement, remember that the evidence indicates that on average it is advantageous to get money in the market as soon as possible, which is why savvy investors try to max out their annual contribution as soon as possible each year around January 1.
Note that contributions must come from earned income, which could include wages, salaries, commissions, bonuses, and business income (if self-employed). The following sources are not eligible:
- rental income
- interest income
- pension income
- annuity income
- stock dividends
- capital gains
Roth IRA Income and Contribution Limits
Now we'll cover the income and contribution limits for a Roth IRA. Note that these typically change every year so the numbers here may be outdated depending on when you're seeing this.
Eligibility to contribute to a Roth IRA is determined by your Modified Adjusted Gross Income, or MAGI for short.
At this time in 2024, the annual contribution limit for individuals for a Roth IRA is $7,000 if below age 50 and $8,000 if age 50 or older, up from $6,500 and $7,500 respectively for 2023.
A working spouse can also make contributions for a non-working (or low-earning) spouse as long as the sum of both spouses’ contributions does not exceed the sum of their incomes.
The current annual income limits to be eligible to contribute to a Roth IRA in 2024 are $161,000 if single and $240,000 if married filing jointly. Phase-outs for reduced allowed contributions begin at $146,000 if single and $230,000 if married filing jointly.
If your income is above those limits, you can use a technique called a “backdoor Roth IRA” where you make a nondeductible contribution to a Traditional IRA and then convert it to a Roth IRA, thereby allowing very high earners to legally get around the income limits.
Also note that your Roth IRA contribution cannot exceed the income you earned for that year.
Here's a recap of those limits in a table:
| Rules | Limit |
|---|---|
| 2023 Contribution Limits | $6,500; $7,500 if age 50 or older. |
| 2024 Contribution Limits | $7,000; $8,000 if age 50 or older. |
| 2023 Income Limits – Single | $153,000; phase-out begins at $138,000. |
| 2024 Income Limits – Single | $161,000; phase-out begins at $146,000. |
| 2023 Income Limits – Married Filing Jointly | $228,000; phase-out begins at $218,000. |
| 2024 Income Limits – Married Filing Jointly | $240,000; phase-out begins at $230,000. |
Roth IRA Infographic
To recap, here's an infographic with the main characteristics of note of a Roth IRA:
How To Open a Roth IRA
Most brokerages like Schwab, Fidelity, Vanguard, etc. offer both Roth IRAs. You'll just choose which one you want when opening a new account. My choice is M1 Finance. The broker has automatic deposits and withdrawals, a sleek mobile app, and dynamic rebalancing of new deposits, among other things. I wrote a comprehensive review of the platform here.
Roth IRA FAQ's
There is no “best” Roth IRA. The account structure and functions are universal; a Roth IRA at Vanguard is the same as a Roth IRA at Fidelity. My choice of broker is M1 Finance.
When did Roth IRA start?
The Roth IRA was established in 1997 by the Taxpayer Relief Act.
Will Roth IRA go up?
Whether or not your Roth IRA goes up in value is going to depend on the assets you've invested in. We expect investments like stocks and bonds to have positive returns over the long term, though of course this is not guaranteed.
Will Roth IRA go away?
The Roth IRA will probably not go away, at least not anytime soon. It is the only individual retirement account that is tax-exempt.
Does Roth IRA reduce taxable income?
No. Roth IRA contributions are made with post-tax money, so they do not reduce taxable income, but withdrawals are tax-free.
Can Roth IRA be used for college?
Technically, yes. Roth IRA contributions can be withdrawn tax- and penalty-free anytime. Earnings can be withdrawn without penalty in special cases, one of which is higher education expenses. Consult your tax professional on your specific situation.
Does Roth IRA have RMDs?
No, Roth IRAs do not have RMDs, or required minimum distributions.
Is Roth IRA safe?
Yes, Roth IRAs as a vehicle would be considered “safe” in the sense that SIPC (Securities Investor Protection Corporation) insurance provides up to $1 million in protection. Your account value is determined by what you've invested in inside your Roth IRA.
Are Roth IRA contributions tax deductible?
No. Roth IRA contributions are made with after-tax dollars. That is, that money has already been taxed, so they are not tax-deductible. Roth IRA contributions are taxed on the front end, but the growth is not taxed on the back end.
Are Roth IRA distributions taxable?
No. Because Roth IRA contributions are taxed on the front end, distributions on the back end are not taxed.
What Roth IRA should I invest in?
Most modern brokers offer Roth IRAs. My choice is M1 Finance. You get to choose what products to invest in inside the Roth IRA account.
Can Roth IRA lose money?
This will depend on what investments you've bought inside your Roth IRA. We expect assets like stocks and bonds to have positive returns over the long term, but this is not guaranteed, and these investments can easily lose money over the short term.
Can Roth IRA be inherited?
Yes. In fact, because the Roth IRA does not have required distributions, it makes a great wealth transfer vehicle.
How does a Roth IRA grow?
Your Roth IRA account value grows based on whatever growth occurs with the investments you choose inside the account.
How is a Roth IRA taxed?
Roth IRA contributions are made with money that has already been taxed. Growth inside the account and distributions are tax-exempt.
When is a Roth IRA started?
There is no age requirement for opening a Roth IRA. Anyone in the U.S. can open one if they have earned income below the income limit.
When does a Roth IRA make sense?
A Roth IRA makes the most sense when you know for sure that your tax rate when withdrawing in retirement will be higher than your current tax rate while contributing.
When do you make Roth IRA withdrawals?
Roth IRA contributions can be withdrawn anytime penalty-free. Roth IRA earnings can be withdrawn penalty-free after age 59.5. Some special cases allow for early withdrawal of earnings without penalty, such as a first-time home purchase, permanent disability, and higher education expenses.
Why is a Roth IRA better than a Traditional IRA?
A Roth IRA is not objectively better than a Traditional IRA. Whether or not it is better is entirely situational. The Roth IRA is the better choice when your tax rate in retirement will be higher than your current tax rate. A Roth IRA also has a little more flexibility in terms of withdrawing contributions anytime and not requiring distributions. I compared the Roth IRA and Traditional IRA in more detail here.
Do you have a Roth IRA? Are you thinking about opening one? Let me know in the comments.
Disclaimer: While I love diving into investing-related data and playing around with backtests, this is not financial advice, investing advice, or tax advice. The information on this website is for informational, educational, and entertainment purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a research report. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. I always attempt to ensure the accuracy of information presented but that accuracy cannot be guaranteed. Do your own due diligence. I mention M1 Finance a lot around here. M1 does not provide investment advice, and this is not an offer or solicitation of an offer, or advice to buy or sell any security, and you are encouraged to consult your personal investment, legal, and tax advisors. Hypothetical examples used, such as historical backtests, do not reflect any specific investments, are for illustrative purposes only, and should not be considered an offer to buy or sell any products. All investing involves risk, including the risk of losing the money you invest. Past performance does not guarantee future results. Opinions are my own and do not represent those of other parties mentioned. Read my lengthier disclaimer here.
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