What is a Roth IRA?

You might’ve heard about Roth IRAs and have a nagging feeling you should learn more. Roth IRAs have unique characteristics that set them apart from traditional IRAs. A Roth IRA is one of the most valuable retirement savings tools available — especially if you start contributing early. Here’s what you need to know.

Understanding Roth IRAs

An IRA (individual retirement account) is a savings tools that gives you tax breaks on saving for retirement. Unlike a 401(k), which is opened by your employer, you open an IRA yourself with a financial institution of your choice. For the most part, all you need is taxable income, and you’ll be eligible for an IRA at a brokerage firm or bank.

Because IRAs are designed for retirement savings, the money you put in them isn’t meant to be taken out until you’ve reached that point in your life. Roth IRAs come in the form of investment accounts, certificates of deposit (CDs) or savings accounts.

Different types of IRAs have their own rules and tax benefits. The most important difference between Roth and traditional IRAs deals with how and when your money is taxed. To put it simply, money that goes into a Roth IRA has already been taxed, meaning you won’t have to pay additional taxes when you make withdrawals during retirement. On the other hand, traditional IRA contributions are tax deductible in the calendar year you make them, and distributions made during retirement are taxed at your current tax rate.

Read more: Compare and contrast the qualities of traditional IRAs and Roth IRAs.

Roth IRAs happen to be the fastest-growing type of IRA because of their unique tax advantages and other saver-friendly qualities.

Roth IRA Rules and Limits

Because of all the tax benefits, Roth IRAs have additional rules and limitations that a traditional savings or investment account doesn’t. They revolve mainly around when you can make penalty-free withdrawals and how much you can contribute each year.

Roth IRA Withdrawal Rules

Like we mentioned, you fund a Roth IRA with post-tax dollars, so you don’t have to worry about paying taxes on your earnings or qualifying withdrawals.

Keep in mind that money taken out before age 59 ½ is considered an early withdrawal. You can withdraw your original contributions at any time, tax- and penalty-free. But if that withdrawal includes any earnings, you’ll pay taxes on them and a 10% IRS penalty. Certain early withdrawals (including earnings) are allowed without penalty by the IRS 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.

Roth IRA Contribution Age Limits

As long as you have earned income, you can contribute to your Roth IRA. This contrasts with traditional IRAs, which you can’t contribute to after age 70½.

If you’re just getting started in your career, a Roth IRA is an ideal way to sock away money for later. You potentially have decades of tax-free growth and compounding interest to benefit from. By starting early and contributing the maximum allowable amount throughout life, you can take full advantage of what experts call the time value of money.

2021 Roth IRA Maximum Contribution Limits

All IRAs, not just Roth, have contribution limits. You can contribute a maximum amount of $6,000 per year to a Roth IRA if you’re 49 and younger. If you’re 50 or older you can contribute $7,000 per year — this is known as “catch up” contributions.

Note that rollover contributions, which occur when your move funds from a 401(k) or other qualified retirement account to a Roth IRA, do not count toward the maximum contribution limit.

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.

Roth IRA Income Limits

The IRS uses a formula to determine how much you can contribute to a Roth IRA based on your income and filing status. Visit the IRS website to see if and how much you are eligible to contribute based on the government-set limits.

If 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. Read on to learn more about converting to a Roth IRA.

How to Open a Roth IRA

Once you’ve decided a Roth IRA is right for you and your financial situation, you’ll find they’re simple to open at your local bank, an online bank (like Ally Bank) or brokerage (like Ally Invest), or with help from your financial advisor.

If you decide to open a Roth IRA with us, you have several options. First, choose between an Ally Bank Online Savings Account, IRA High Yield or IRA Raise Your Rate CD or an IRA investment account with Ally Invest. No matter which you decide, setting up an account is easy to do and can be completed in just minutes by following our guided signup process.

Learn more: Here’s how to open an IRA in three simple steps.

Should you choose open an Ally Invest investment account for your Roth IRA, you can decide between Self-Directed Trading or a Robo Portfolio. Either way, you’ll receive the great benefits a Roth IRA provides while getting as much or as little investing assistance as you prefer.

Is now the right time to convert to a Roth IRA?

A Roth IRA can be a useful tool for growing your retirement savings. But it’s a good idea to weigh whether converting to one from a traditional IRA is right for you based on factors like your income and age. By using a calculator like Bankrate’s Roth IRA vs. Traditional IRA or Convert IRA to Roth calculators, you can get a better understanding of how making the switch will affect your money in the long run.

You should also consider any tax implications before converting a traditional IRA to Roth. This is because when you convert a traditional IRA to a Roth IRA, you have to pay taxes on those funds, which may result in a substantial tax bill. If you are thinking about making this conversion, be sure to speak with a tax professional to fully understand if and when doing so makes sense.

A better retirement begins today.

Saving for retirement doesn’t need to be overly complicated, especially when using a tool like a Roth IRA. In fact, the toughest step may just be deciding to open one. Then, you can put your savings on autopilot — and enjoy the benefits of potentially earning tax-free returns.

Save for retirement your way with a traditional or Roth IRA.

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