What is a Roth IRA?

This individual retirement account allows you to make tax-free withdrawals in retirement

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A Roth IRA is an individual retirement account that allows you to contribute after-tax dollars up to a certain limit each year. These are tax-advantaged accounts, allowing your investments to grow tax-free, and you can withdraw funds tax-free in retirement.

The Roth IRA is a popular choice for many investors due to its tax advantages and flexibility. While Roth IRAs share some similarities with traditional IRAs, they also have some distinct differences that make them an attractive investment choice.

Key insights

  • A Roth IRA is a special type of retirement account that allows you to withdraw funds tax-free after age 59½.
  • Roth IRAs are ideal for investors who anticipate a higher tax rate in retirement.
  • Roth IRAs allow you to invest $6,500 per year (or $7,500 if age 50 or older).
  • Roth IRAs are available through most major brokerage firms and investing apps.

How does a Roth IRA work?

Roth IRAs are a type of individual retirement account that allows you to deposit income that you’ve already paid taxes on and invest in stocks, bonds and other assets. The growth from your Roth IRA investments is not taxed, and you can withdraw from your Roth IRA after age 59½ without paying any income taxes.

“A Roth IRA is a type of retirement account that provides tax-free growth,” said Carman Kubanda, a financial planner at Innovative Wealth Building. “When done correctly, you pay the taxes on the contributions now but after you turn 59½ years old you can access all of the money without paying a cent in taxes.”

You must have earned income to invest in a Roth IRA account, and you can only invest as much as you’ve earned for the year.

After you turn 59½ years old you can access all of the money without paying a cent in taxes.”
— Carman Kubanda, Innovative Wealth Building

Contributions to your Roth IRA account can be made in a few different ways, including:

  • Regular deposits
  • A rollover from another retirement plan, such as a 401(k)
  • A transfer if you switch where your Roth IRA account is managed
  • Conversion of traditional IRA funds to a Roth IRA

Contributions must be cash, check or money orders (not property or other securities).

Roth IRAs are flexible in that you can withdraw your principal investment at any time without any tax consequences. Roth IRAs are also not subject to required minimum distributions (RMDs), an IRS requirement for other retirement accounts that dictates a minimum amount you must withdraw annually. This means you can keep your Roth IRA open as long as you’d like and keep the funds in there indefinitely.

Spousal Roth IRA
If you have a spouse who earns little to no income, there is a provision in the IRS code that allows you to fully fund a spousal Roth IRA based on your earnings. This means you can deposit up to $6,500 into a spousal Roth IRA (or $7,500 if your spouse is age 50 or older).

There are some requirements your spouse must meet in order to qualify for a spousal Roth IRA:

  • You must be married and filing a joint tax return
  • You must have earned income to cover your contributions and your spouse’s contributions
  • Your income must not exceed the Roth IRA income limits

How to open a Roth IRA

To open a Roth IRA, you first need to find an eligible investment broker or financial institution that offers IRA accounts. Then, you can open an account and contribute funds up to the annual limit.

Opening a Roth IRA can be done online and typically requires providing the following information:

  • Personal information
  • Financial information (including bank account for transferring funds)
  • Employment information
  • Social Security number
  • Identity verification documents

You can open a Roth IRA at any time, but you must have established earned income for the year before you can contribute money to it. In general, you need to have earned at least as much as you plan on contributing.

Where to open a Roth IRA

You can open a Roth IRA through a bank, credit union, broker or other financial institution that offers IRA accounts. Most online brokers offer IRA accounts, as do most investment firms.

The easiest way to open an IRA is through an online broker, such as Fidelity, Vanguard or Charles Schwab. It’s important to choose a reputable broker that offers a wide range of investments to choose from so you can diversify your investments within your Roth IRA account.

» MORE: What is a good investment?

Roth IRA limits

Roth IRA accounts are regulated by IRS rules that impose a few limitations on who can open one and how much you can contribute. It’s important to understand these limitations so you know if you qualify and exactly how much you can put into the account each year.

Roth IRA contribution limits 2023

When contributing to an IRA, you cannot exceed the annual contribution limits. The limits are set by the IRS and may be increased every few years. Here are the 2023 contribution limits:

  • Up to $6,500
  • Up to $7,500 if age 50 or older
  • Up to total earned income (if less than annual Roth IRA contribution limit)

However, contribution limits may be reduced based on your modified adjusted gross income (MAGI) and tax filing status (see below).

Roth IRA income limits 2023

You can’t contribute to a Roth IRA if you make too much money. The IRS sets income limits each year for Roth IRA accounts, limiting the amount you can contribute, or rendering you ineligible if you make over the maximum allowed amount.

Here are the income limits by tax filing status:

With a partial contribution, you’ll need to review the reduced contribution limits worksheet in IRS Publication 590-A to calculate your eligible contribution for the year.

» MORE: How much do I need to retire?

Roth IRA withdrawal rules

Similar to other retirement accounts, the Roth IRA allows withdrawals after age 59½. You can withdraw funds tax-free, and there are no extra fees or penalties assessed. You can also withdraw your principal investment from your Roth IRA at any time without taxes or penalties.

But if you withdraw funds early in a nonqualified distribution, you may get hit with a 10% penalty from the IRS and even get taxed on the funds withdrawn.

The Roth IRA is a more flexible account than most other retirement accounts, as you can access some of your funds (penalty- and tax-free) at any time. There are a few exceptions that allow you to withdraw funds early, including:

  • Withdrawing principal investment funds
  • Qualified education expenses
  • Unreimbursed medical expenses or health insurance if you're unemployed
  • Qualified expenses related to a birth or adoption
  • The distribution is made in substantially equal periodic payments (SEPP)
Roth IRA 5-year rule
Your Roth IRA offers flexibility, but to be able to access your funds early, the Roth IRA account must be open for at least five years. This is known as the “five-year rule,” and it governs whether you’ll be taxed on early withdrawals from your Roth IRA.

After your Roth IRA has been open for five years, there are a few exceptions that allow you (or your beneficiary) to access your funds early:

  • Can withdraw up to $10,000 as a first-time homebuyer for a home purchase
  • Can withdraw funds if you become disabled
  • Your beneficiary can withdraw funds if you pass away
Nonqualified distributions
Nonqualified distributions from your Roth IRA are funds that are withdrawn early (before age 59½) and do not qualify as an exception. This means withdrawing Roth IRA funds before the account has been open for five years, or for anything other than qualified expenses, such as first-time homebuyer expenses or birth or adoption expenses.

If you take a nonqualified distribution from your Roth IRA, you will have to pay income taxes on those distributions, as well as an additional 10% penalty tax assessed by the IRS. This is a major blow to your retirement savings, so it’s important to exhaust other financing options before resorting to a nonqualified Roth IRA distribution.

Roth IRA vs. traditional IRA

Roth IRA and traditional IRA accounts share some similarities, such as annual contribution limits and withdrawal rules, but they function very differently with regard to taxes and accessibility.

Roth IRA conversion

Roth IRA accounts are unique in their ability to grow tax-free and be withdrawn in retirement without paying any income taxes. And if you have money in a traditional IRA, you might want to consider a Roth IRA conversion.

Roth IRA conversion is a recharacterization of traditional IRA funds to become Roth IRA funds. Since the traditional IRA funds were tax-deductible in the year you contributed, you will be required to pay ordinary income taxes on the amount converted.

Once converted, the funds will grow in your Roth IRA tax-free and can be withdrawn tax-free in retirement. Plus, they are not subject to RMDs, which can help you control your income taxes in retirement further.

But the funds must be held in the Roth IRA for five years before they are accessible tax-free in retirement — and before you can access the funds in a qualified distribution.

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Why is it called a Roth IRA?

The Roth IRA is named after former Delaware Sen. William Roth. He was a proponent of lower taxes and introduced a bill for the creation of the “IRA Plus,” which would allow tax-free withdrawals in retirement. It eventually made it into the Taxpayer Relief Act of 1997, and was dubbed the “Roth IRA.”

How does a Roth IRA grow?

A Roth IRA is a retirement account that allows you to invest in assets within the account itself. The account does not grow, but the investments held inside the account can grow. Whether you invest in certificates of deposit, stocks, bonds or other assets, as those grow in value, you do not pay any additional taxes on them.

How much should I contribute to my Roth IRA?

When saving for retirement, it’s a good idea to contribute as much as you are comfortable with in tax-advantaged accounts. If you choose to contribute to a Roth IRA, the maximum amount allowed is currently $6,500 per year (or $7,500 if age 50 or older).

When can you take money out of a Roth IRA?

You can take money out of your Roth IRA, tax- and penalty-free, starting at age 59½. But there are exceptions available to withdraw funds early, including withdrawing contributions after the account has been open for five years, or using funds for educational expenses.

What is a “backdoor” Roth IRA?

A “backdoor” Roth IRA is a strategy used by high-income earners to get around the income limits for Roth IRA accounts. To perform a backdoor Roth IRA conversion, you need to first open an IRA (or contribute to one with no balance), deposit funds and then fill out IRS Form 8606 to characterize those contributions as “nondeductible.” Then, you can convert the account to a Roth IRA account.

Bottom line

Roth IRAs are one of the most flexible and powerful investment accounts available. With multiple tax benefits and the ability to access funds early, a Roth IRA can help you save for retirement while maintaining flexibility with your funds.

However, Roth IRAs do have limits, and if your income is too high, you may not be able to contribute to one directly. It’s best to work with a licensed financial advisor who can help you pick the best investment accounts for your retirement plan.

Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
  1. IRS, “ Publication 590-A .” Accessed Sept. 14, 2023.
  2. IRS, “ Publication 590-B .” Accessed Sept. 14, 2023.
  3. Congress.gov, “ H.R.2014 - Taxpayer Relief Act of 1997 .” Accessed Sept. 14, 2023.
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