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What is a Roth IRA and how to open one

Enjoy tax-free withdrawals of your retirement savings when you open a Roth IRA.

A Roth IRA is a type of individual retirement account (IRA) that allows tax-free growth on your investments and tax-free withdrawals in retirement. Created in 1997 as part of the Taxpayer Relief Act, these tax-advantaged investment accounts are the second-most frequently owned IRA after the traditional IRA, with more than 32 million US households owning one in 2022.

Roth IRAs provide not only several tax benefits but also flexibility when it comes to withdrawing your money. Contributions you make to a Roth IRA are made with money on which you’ve already paid taxes. And since the IRS has already taken its share, individuals can withdraw contributions at any time, tax- and penalty-free.

What’s more, there are no required minimum distributions (RMDs) during your lifetime. Meaning you aren’t required to start withdrawing from your Roth IRA when you turn the age of 72, as is the case with a traditional IRA. But unlike a traditional IRA, you cannot deduct Roth IRA contributions.

Key takeaways

  • You fund a Roth IRA with dollars that have already been taxed, and qualified withdrawals are tax-free.
  • Because you pay taxes now, Roth IRAs are ideal for those who think they’ll be in a higher income tax bracket when they retire.
  • Only those under a certain income level qualify to open and contribute to a Roth IRA.

How does a Roth IRA work?

A Roth IRA is a type of investment account that lets you benefit from various tax advantages while you save for retirement. A Roth IRA operates much like its traditional IRA counterpart: same total contribution limits, same early-withdrawal penalties and same flexibility when it comes to the types of allowable investments. But with a Roth IRA:

  • You cannot deduct contributions.
  • Income limits apply.
  • Qualified withdrawals in retirement are tax-free.
  • You are not required to take distributions once you reach a certain age.

Are Roth IRAs insured?

IRAs may be covered by either the Securities Investor Protection Corporation (SIPC) and the Federal Deposit Insurance Corporation (FDIC), or both. Protection is against loss in the event the bank or brokerage fails, not loss from the performance of the investment. Insurance eligibility depends on your assets and the standing of the bank or brokerage.

IRAs that contain bank deposits such as CDs, savings accounts or money market accounts and are held at an FDIC-insured bank or institution are generally insured by the FDIC up to $250,000 per account holder. Investment products such as stocks and mutual funds in an IRA account are not FDIC-insured. Still, securities and cash held at a SIPC-insured bank or brokerage are covered by the SIPC up to $500,000.

Roth IRA income and contribution limits

In 2024, the contribution limit for all your IRAs — that’s both traditional and Roth IRAs — is $7,000 (or $8,000 if you’re age 50 or older). If your modified adjusted gross income (MAGI) for the year is less than $146,000, or $230,000 if married filing jointly, you can contribute up to the full $7,000. Once your MAGI exceeds that amount, your maximum contribution begins to diminish until you can’t contribute at all to a Roth IRA (unless you go the backdoor Roth IRA route).

While income limits apply, Roth IRAs have no age limits. Anyone with earned income, even minors, can contribute to a Roth IRA.

You have until the next tax return filing deadline to contribute to a Roth IRA for the prior year. For example, you can make 2023 Roth IRA contributions until April 15, 2024.

Married filing jointly or qualifying widow(er)

Modified AGIContribution
< $230,000up to the limit
≥ $230,000 but < $240,000a reduced amount
≥ $240,000Zero

Married filing separately (lived with your spouse at any time during the year)

Modified AGIContribution
< $10,000a reduced amount
≥ $10,000zero

Single, head of household or married filing separately (did not live with your spouse at any time during the year)

Modified AGIContribution
< $146,000up to the limit
≥ $146,000 but < $161,000a reduced amount
≥ $161,000zero

Roth IRA taxes

Roth IRA contributions are made using after-tax dollars. As such, the money you save isn’t tax-deductible like it is with a traditional IRA. But since contributions are made using money on which you’ve already paid taxes, you can withdraw your contributions at any time without taxes or penalties. Meanwhile, all the earnings on your investments grow free of tax.

If you’re at least 59 and a half years old at the time you withdraw earnings from a Roth IRA and your account has been open for at least five years (more on this later), you won’t owe federal income tax on your withdrawals.

Withdrawing earnings before the age of 59 and a half will trigger both regular income tax and a 10% early withdrawal penalty. That said, there are a number of exceptions that would waive the additional 10% penalty. The following list isn’t exhaustive, but some exceptions include:

  • You become totally and permanently disabled.
  • You use the money to pay health insurance premiums while unemployed.
  • You use the money for qualified higher education expenses.

How to open a Roth IRA

  1. Choose a Roth IRA custodian. Explore and compare IRA custodians, considering things like investment options, fees, customer support and platform functionality.
  2. Complete your application. Most IRA custodians offer simple online application processes. Be prepared to supply personal information, such as your name, date of birth and Social Security number.
  3. Fund your account. Fund your Roth IRA with a check or bank transfer. If you have an existing retirement account, you may be able to roll over those funds into your new IRA.
  4. Select your investments. Choose from stocks, bonds, exchange-traded funds (ETFs) or any other assets available with your IRA custodian.

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Roth IRA investment options

Federal law permits most types of investments in an IRA, except life insurance or collectibles. Allowable investments include:

While many assets are allowed in a Roth IRA, available investments ultimately depend on what the IRA custodian offers. Most major banks and brokers impose restrictions on alternative investments because of regulatory requirements and added red tape and instead stick with offering only traditional assets, such as stocks, bonds and ETFs. To diversify your IRA with alternative investments like crypto and real estate, find a custodian that offers self-directed IRAs.

Roth IRA rules you need to know

Roth IRAs are flexible retirement accounts, but they have unique rules you need to be aware of.

Roth IRA income rules

You can only contribute to a Roth IRA if you meet certain income criteria. The IRS determines your eligibility to contribute to a Roth IRA based on your tax filing status and your MAGI. Your MAGI is your adjusted gross income plus certain deductions, like student loan interest or qualified tuition expenses.

For example, if you are single, head of household or married filing separately, you cannot contribute to a Roth IRA if your 2024 MAGI is above $161,000. Married couples filing jointly cannot contribute to a Roth IRA with a 2024 MAGI over $240,000. It’s important to remember that the IRS considers your MAGI and not your gross income. So even if your gross income is above the income limit, you may still qualify to make Roth IRA contributions if any applicable deductions lower your MAGI below the threshold.

These income rules are meant to enforce fairness and prevent high-paid workers who can afford to save large amounts of their salary from benefitting more than the average worker.

5-year rule

While the withdrawal rules for Roth IRAs are more flexible than traditional IRAs, there’s one Roth-specific withdrawal rule to know about.

The 5-taxable-year period of participation — or 5-year rule — stipulates that you cannot withdraw earnings tax-free until you’ve participated in your Roth IRA for at least five years. The clock starts on the first day of the taxable year in which you first made a contribution. For example, if you first contribute to a Roth IRA on September 3, 2024, the clock starts January 1, 2024 — the first day of the taxable year.

The 5-year rule applies regardless of age. So if you first contribute to a Roth IRA at age 58, you must wait until age 63 to begin taking qualified distributions from your account. For this reason, it could be a good idea to contribute any amount to your Roth IRA as soon as possible to start the clock.

Roth IRA withdrawal penalty

The IRS views your distributions as either qualified or nonqualified. It considers distributions to be qualified if you’re the age of 59 and a half or older and your Roth IRA is at least five years old. A nonqualified distribution is any distribution that doesn’t meet these requirements, and they’re typically subject to tax and penalties.

Here’s a breakdown of how the IRS treats distributions with the 5-year rule and 59-and-a-half age threshold in mind.

If you meet the 5-year rule:

  • And are under the age of 59 and a half, a withdrawal is considered a nonqualified distribution and the earnings portion is subject to taxes and the 10% early-withdrawal penalty.
  • And are over the age of 59 and a half, no taxes or penalties apply.

If you don’t meet the 5-year rule:

  • And are under the age of 59 and a half, a withdrawal is considered nonqualified and the earnings portion is subject to taxes and the 10% early-withdrawal penalty.
  • And are over the age of 59 and a half, a withdrawal is considered nonqualified and your earnings are subject to taxes but not penalties.

Roth IRA vs. traditional IRA

The main difference between a Roth and a traditional IRA is tax treatment. Only contributions made to traditional IRAs are tax-deductible, while qualified withdrawals from a Roth IRA are tax-free.

IRAs at a glance

RothTraditionalSEP (Simplified Employee Pension)SIMPLE (Savings Incentive Match Plan for Employees)Self-directed
Who it’s forYou’re under the income limit threshold

You think you’ll be in a higher income tax bracket in retirement

You want to deduct your contribution

You think you’ll be in a lower income tax bracket in retirement

Business owners with or without employees who want tax-deductible contributionsSmall business owners not currently sponsoring a retirement planYou want to invest in both traditional and alternative assets
2024 max contribution$7,000 ($8,000 if you’re age 50 or older)$7,000 ($8,000 if you’re age 50 or older)Business owners can contribute up to the lesser of $69,000 or 25% of an employee’s salaryEmployees can contribute up to $16,000 from their salary

Employers are required to match each employee’s elective-deferral contributions, dollar-for-dollar, up to 3% of the employee’s compensation

Contribution limits depend on whether the IRA functions as a traditional, Roth or SEP IRA
Are contributions tax-deductible?NoYes, but your eligibility and the amount you can deduct depends on your tax filing status, MAGI and whether you have a workplace retirement planYes, employers can deduct the lesser of their contributions or 25% of the employee’s compensationNot for employees

Business owners can deduct all contributions made to an employee’s SIMPLE IRA

Sole proprietors can deduct their own salary reduction contributions and their own matching or nonelective contributions

The same tax deduction rules for standard traditional, Roth, SEP and SIMPLE IRAs apply

Benefits and drawbacks of Roth IRAs – are they worth it?

Pros

  • Tax-free growth
  • Qualified withdrawals are tax-free
  • No required minimum distributions
  • The IRS permits most investments, except life insurance or collectibles
  • You can withdraw contributions at any time, tax- and penalty-free

Cons

  • Maximum yearly contribution amounts are relatively low
  • Contributions are not tax-deductible
  • Income limits to making contributions

About a third of American choose an IRA

Do you have an IRA?

Response% of Americans
I do not have this, but plan on getting it in the next 6 months13%
I do not have this nor plan on getting it56%
I currently have this31%
Source: Finder survey by Qualtrics of 2,033 Americans

While a little less than a third (31%) of American adults say that they’re currently invested in an IRA, an additional 13% do plan on opening one in the next six months.

Bottom line

A Roth IRA is an investment vehicle that offers both valuable tax benefits and flexibility when it comes to withdrawing your money. Qualified distributions are tax-free, making Roth IRAs particularly beneficial if you expect to retire at a higher tax bracket or you’re many years away from retirement and expect a lot of growth on your investments.

Roth IRA investment options largely depend on the custodian, so shop around to find the best Roth IRA account for you.

Frequently asked questions about Roth IRAs

Matt Miczulski's headshot
To make sure you get accurate and helpful information, this guide has been edited by Matt Miczulski as part of our fact-checking process.
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Written by

Writer

Frank Corva is business-to-business (B2B) correspondent for Bitcoin Magazine and formerly the cryptocurrency writer and analyst for digital assets at Finder. Frank has turned his hobby of studying and writing about crypto into a career with a mission of educating the world about this burgeoning sector of finance. He worked in Ghana and Venezuela before earning a degree in applied linguistics at Teachers College, Columbia University. He also taught writing and entertainment business courses in Japan and worked with UNICEF in Namibia before returning to the US to teach at universities in New York City. Earlier in his career, he spent years working as a publicist and graphic designer for record labels like Warner Music Group and Triple Crown Records. During that time, he was also a music journalist whose writing and photography was in published in Alternative Press, Spin and other outlets. See full bio

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