You’ve heard about Roth IRAs, but do you have a nagging feeling you need to learn more? Roth IRAs are some of the most valuable retirement savings tools available—especially if you start contributing early. Here’s what you need to know.
Roth IRAs can help you save for retirement.
IRAs (individual retirement accounts) in general are savings tools that give you tax breaks on saving for retirement. Unlike a 401k, an IRA is opened by you and not your employer. For the most part, all you need is taxable income and you can open an IRA at a brokerage firm or at your bank.
There are a few types of IRAs available, all with their own rules and tax benefits. Roth IRAs happen to be the fastest-growing type of IRA because of their unique tax advantages and other saver-friendly qualities.
You can contribute to your Roth IRA at any age.
As long as you have earned income, you can contribute to your Roth IRA. This feature is in contrast to traditional IRAs, which you can’t contribute to after age 70½. (You can compare the other features of Roth and traditional IRAs here.)
Contributions to a Roth IRA are taxed—distributions aren’t.
You fund a Roth IRA (individual retirement account) with post-tax dollars. Since you pay taxes on the front end, you don’t have to worry about paying taxes on your earnings or qualifying withdrawals.
Money you take out before age 59 ½ is considered an early withdrawal. You can withdraw your original contributions at any time, tax- and penalty-free. However, if you make an early withdrawal of funds that include your earnings, you’ll pay taxes on the earnings and a 10% IRS penalty. There are some allowable IRS categories for early withdrawals that include your earnings without penalty should you fall on hard times.
Once you reach age 59½, you can withdraw your funds—including earnings—tax-free, as long as the money has been in the IRA for at least five years.
Starting early lets you make the most of tax-free growth.
If you’re just getting started in your career, a Roth IRA is an ideal way to sock away money for later. You’re used to paying taxes on your income anyway, so you’re not looking for the up-front tax deduction from a traditional IRA.
Plus, you potentially have decades of tax-free growth and interest compounding to benefit from. Starting early and contributing the maximum allowable amount lets you take full advantage of what experts call the time value of money.
Roth IRAs have income eligibility limits.
You can’t contribute to a Roth IRA if your income exceeds government-set limits, so check the IRS website to see if your income allows you to be eligible for a Roth IRA.
If it turns out that you make too much money to open a Roth IRA, you may be able to convert some of the assets in your traditional IRA to a Roth. You will have to pay taxes on that amount, so be sure you understand the conversion and rollover rules before you make that move.
Roth IRAs have maximum contribution limits.
In fact, all IRAs have contribution limits. In general, you can contribute a maximum amount of $5,500 per year to a Roth IRA if you’re 49 and younger. If you’re 50 or older you can contribute $6,500 per year.
However, even if your income allows you to be eligible to open a Roth IRA, your income and tax filing status may affect whether you can contribute the maximum amount each year. The reduced amount you can contribute is based on an IRS formula.
Estate planners like Roth IRAs.
Roth IRAs don’t require you to make mandatory withdrawals, or “take distributions,” to use IRA lingo. This means your account balance can continue to grow. While that can be useful for you during your lifetime, it’s especially good news for any beneficiaries who can inherit the full amount. In addition, heirs don’t pay income taxes on inherited Roth IRAs, they just have to take distributions over their lifetimes.
Opening and maintaining Roth IRA can be simple.
Once you’ve figured out that a Roth IRA is a good fit for your situation, you can open one at your local bank, online bank, or with the help of your financial advisor. And maintaining it doesn’t require a lot of effort, especially if you automate contributions.
Last Edited: March 26, 2018