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What is a Roth IRA?
Enjoy tax-free withdrawals of your retirement savings when you open a Roth IRA.
A Roth IRA is a retirement savings account that allows tax-free growth on your investments. Withdrawals also are tax free on a federal basis if you meet these requirements:
- Are at least 59.5 years old
- Had the account open for at least five years
However, nonqualified withdrawals generally trigger an early withdrawal penalty and federal income tax.
You can open a Roth IRA at most banks and brokerages. But some charge no management fees and require no minimum deposits to open. So be sure to compare your options.
What's in this guide?
How do Roth IRAs work?
When you open a Roth IRA, you can build a retirement investment portfolio with a variety of assets.
- Stocks
- Bonds
- Mutual funds
- ETFs
- Certificates of deposit (CDs)
- Cash
You fund a Roth IRA with “after-tax” dollars. This means you’ve already paid income tax on that money, so you can withdraw your contributions any time penalty- and tax-free.
However, Roth IRAs have contribution limits set each year by the IRS and based on your modified adjusted gross income (MAGI). For 2020 and 2021, that limit is $6,000 — or $7,000 if you’re age 50 or older.
But that limit applies to you if your MAGI is less than $124,000 — or $196,000 if married filing jointly. Once your MAGI goes above that amount, your maximum contribution begins to diminish until you can’t contribute at all.
Married filing jointly or qualifying widow(er)
| Modified AGI | Contribution |
|---|---|
| < $196,000 | up to the limit |
| > $196,000 but < $206,000 | a reduced amount |
| > $206,000 | zero |
Married filing separately
| Modified AGI | Contribution |
|---|---|
| < $10,000 | a reduced amount |
| > $10,000 | zero |
Single, head of household or married filing separately
| Modified AGI | Contribution |
|---|---|
| < $124,000 | up to the limit |
| > $124,000 but < $139,000 | a reduced amount |
| > $139,000> | zero |
You have until the next tax filing deadline to reach your maximum Roth IRA contribution.
- How are my distributions taxed after retirement? If you’re at least 59.5-years-old and the account has been open for at least five years, you won’t owe federal income tax on distributions. You can withdraw your contributions anytime tax free.
- Are there age limits on Roth IRA contributions? There are no age limits on Roth IRA contributions if you have earned income.
- Are there income limits on Roth IRAs? Yes. For 2021, if your modified adjusted gross income (MAGI) is more than or equal to $139,000 — or $206,000 if married filing jointly — you can’t contribute to a Roth IRA.
- Are there required minimum distributions associated with Roth IRAs? Roth IRAs don’t require minimum distributions (RMD). This means you can keep making contributions as long as you live without having to make any withdrawals, and your earnings keep growing tax-free.
- What are the penalties for early withdrawal? If you withdraw money from a Roth IRA before you turn 59.5., you’d generally face a 10% penalty and regular income tax on the earnings portion of the withdrawal. There are some exceptions that would waive the penalty but not taxes if you make a withdrawal before reaching age 59.5.
- Are Roth IRAs insured? Investment securities such as stocks and mutual funds in an IRA account are not FDIC insured. However, IRAs held in bank deposit accounts such as CDs and money market accounts generally are. These are insured up to $250,000 per account holder per insured bank for each permissible deposit account type.
How do I open a Roth IRA?
You can open a Roth IRA at most banks and brokerage firms. Simply visit their website or a branch. Be ready with the following.
- Social Security number
- External bank account information
- Proof of income such as a W-2 form
What kinds of income can you contribute to a Roth IRA?
You can contribute only “earned income” or what the IRS calls taxable compensation, to a Roth IRA. This includes the following.
- Wages, salaries and tips from an employer or from self employment
- Commissions
- Professional fees
- Nontaxable combat pay
How do I roll over a traditional IRA or 401(k) into a Roth IRA?
When you roll over money from a traditional IRA or 401(k) into a Roth IRA, you must pay taxes on the amount transferred. Your traditional IRA or 401(k) contributions and investment gains will be added to your taxable income for the year you made the transfer. That’s because the money you put into a traditional IRA is tax deductible, and you don’t pay taxes on it until you withdraw it at retirement. But qualified withdrawals from a Roth IRA are tax-free. In other words, Uncle Sam won’t give you both tax breaks.
Speak to an accountant about the tax implications of a rollover. If it makes sense, you have two options to rollover an IRA or 401(k) into a Roth IRA.
Trustee-to-trustee transfer or direct rollover
This is the simplest way to convert to a Roth IRA. Contact the financial institution holding your existing account and ask for a trustee-to-trustee transfer or direct rollover into your Roth IRA with another financial institution.
Transfers may be even easier if both accounts are with the same financial institution. But some firms may not allow this kind of transfer or rollover.
Indirect rollover
If the financial institution holding your 401(k) or IRA sends you a check or any payment of your account’s assets, you have 60 days to roll it over to a Roth IRA. Otherwise, you may face an early withdrawal penalty. So contact the financial institution holding your Roth IRA as soon as possible.
You may need to send a check by mail. If you get a payment from your 401(k) provider, your employer must withhold 20% for tax purposes. The only way around this is a direct rollover as described above.
Compare retirement accounts
Disclaimer: The value of any investment can go up or down depending on news, trends and market conditions. We are not investment advisers, so do your own due diligence to understand the risks before you invest.
Bottom line
A Roth IRA offers multiple tax benefits. It can be particularly beneficial if you expect to retire at a higher tax bracket than you’re in now, you’re many years away from retirement and expect a lot of growth, or if you think tax rates will increase substantially, because you’ll be able to withdraw your investment earnings tax free.
But management fees and fund expense ratios can diminish these returns. So make sure you compare brokerage platforms to find the Roth IRA that’s right for you.
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