Whether you're looking into opening a retirement account for the first time or exploring options for growing or managing your existing retirement savings, you'll likely come across the Roth IRA. The Roth IRA has some unique features that may benefit your financial situation, but all of the rules can be confusing, especially when comparing with other types of retirement accounts.
You may have questions. How much can you contribute to a Roth IRA? When can you withdraw money tax-free? When should you convert your traditional IRA to a Roth IRA? You'll find your answers here.
- A Roth IRA is a type of individual retirement account (IRA) that allows you to withdraw money tax-free, given a few rules and conditions.
- The IRS sets limits on the amount of money you can contribute to a Roth IRA each year.
- Unlike many other types of retirement accounts, Roth IRAs do not have required minimum distributions (RMDs) at a certain age.
- There is some flexibility with Roth restrictions through such features as spousal contributions, Roth conversions, and designated Roth accounts.
How Does a Roth IRA Differ From a Traditional IRA?
Though there are a number of different rules that govern each type of account, the main difference between a Roth IRA and a traditional IRA is in their tax treatment.
- In a traditional IRA, the funds you contribute are tax-deductible, up to a certain limit. Then you pay taxes on distributions down the road during retirement.
- With a Roth IRA, you contribute funds that are taxed upfront, and then there is no taxation of your withdrawals when you retire (as long as you stay within the rules and limits of the account).
What Are the Major Pros and Cons of a Roth IRA?
Roth accounts offer one of the only ways you can grow money tax-free. The Roth retirement account is designed to help individuals save for retirement and eliminate any taxes owed when funds are withdrawn.
The major downside to a Roth is that there is a maximum allowable contribution amount—and if your income is too high, you can't make a Roth IRA contribution. There are a few ways to work around this: You may be able to contribute to a Roth Account through your 401(k) plan, and at any income level, you can convert a traditional IRA to a Roth.
Who Is Eligible To Contribute to a Roth, and How Much Can You Contribute?
Wondering how much you can contribute to a Roth IRA or if you make too much to contribute?
You must have earned income to contribute. Or, if married, as long as you have enough earned income, you can make a spousal Roth contribution even if your spouse has no earned income. And if you have too much earned income, you can't contribute to a Roth IRA—although you may still be able to contribute to a Roth 401(k) or use a Roth conversion.
The limits on Roth IRA contributions are subject to change each year. Be sure to research the latest Roth IRA contribution limits and earned income rules at the IRS website.
Are Roth IRA Withdrawals Tax-Free?
There's a mass of messy information out there about Roth IRA withdrawals. The bottom line is, most of the time, your Roth IRA withdrawal will be tax-free.
The notable exception to tax-free withdrawals is that income earned on investments inside the Roth may be taxable if you take a non-qualified withdrawal. And amounts you converted to a Roth from a traditional retirement plan may be subject to taxes if you take the money out too soon after conversion.
Do Roth IRAs Have Required Minimum Distributions (RMDs)?
Unlike traditional IRAs, regardless of age, you are not required to take distributions from a Roth. You can leave the account to grow and pass it along to your heirs tax-free.
If you decide to take a distribution before age 59 1/2, or before you have had the Roth for at least five years, read the withdrawal rules carefully to see if you'll owe tax on any portion of the withdrawal. If you are disabled or paying for first-time home-buyer expenses, you'll likely qualify for an exception to any early withdrawal penalty taxes.
What Is a Roth Conversion, and Should I Do It?
With a Roth conversion, you take a withdrawal from a traditional IRA or 401(k) and convert it to a Roth. You'll pay ordinary income taxes on the withdrawal amount but not early withdrawal penalty taxes.
A Roth conversion makes sense for many folks who want their money to grow tax-free.
Roth conversions can be complicated, so if you have a financial advisor or tax expert to lean on, consider having a second set of eyes double-check your calculations.
What Are the Differences Between Roth 401(k)s, Regular 401(k)s, and Roth IRAs?
More and more employers are offering the option to contribute to a designated Roth account through their employer-sponsored 401(k) plan. The great thing about this is that you can contribute an amount up to the 401(k) salary deferral limit, which is a much larger amount than the Roth IRA maximum contribution limit.
Encourage your employer to offer a Roth option in the 401(k) plan. You can even contribute half to the traditional deductible 401(k) and half to the Roth.