Retirement Accounts
Roth IRA accounts are popular because they help ease the tax burden in retirement.
R. Tyler End, CFP®
Published February 8th, 2024
Updated February 28th, 2024
R. Tyler End, CFP®
•
Published February 8th, 2024
•
Updated February 28th, 2024
Table of Contents
Key Takeaways
IRA stands for “individual retirement account.”
You can get an IRA from a variety of online and local brokers, as well as through robo-advisor apps.
With a Roth IRA, you put money in now, after already paying taxes on it, in exchange for tax-free distributions at retirement.
Employers traditionally offer retirement savings accounts as a perk. However, you don’t have to rely on an employer to set money aside for later. You can invest in an individual retirement account (IRA) designed to fund your retirement.
There are two types of IRAs: Traditional and Roth. Like a 401(k), a Traditional IRA allows you to contribute money before paying taxes. Conversely, with a Roth IRA, you contribute money after paying taxes.
What is a Roth IRA?
A Roth IRA is a retirement savings account that allows your money to grow tax-free, with withdrawals in retirement also being tax-free, funded with after-tax dollars.
Often when someone asks what is a Roth IRA, it’s in comparison to a Traditional 401(k) or a Traditional IRA. While it’s great to have retirement savings taken out of your check before your income is taxed, there’s a price to pay. When you retire, you’ll owe taxes on the money.
Roth IRA accounts are popular because they help ease the retirement tax burden. They lock in the certainty of taxes you will pay on this account because you’re paying those taxes now. You may be living on a limited income at retirement time, so the break in income taxes will be a relief.
How to Open a Roth IRA
A Roth Individual Retirement Account (Roth IRA) is a powerful tool for retirement savings, offering tax-free growth and tax-free withdrawals in retirement. Unlike traditional IRAs, contributions to a Roth IRA are made with after-tax dollars, which means you pay taxes on the money before it goes into your account.
Here's how to open a Roth IRA and build a more secure financial future.
Step 1: Determine Your Eligibility Before opening a Roth IRA, ensure eligibility. Your ability to contribute to a Roth IRA depends on your income level. The IRS sets income limits that are updated annually, so check the current limits to see if you qualify. Generally, if you earn too much, you may be partially or entirely phased out from contributing.
Step 2: Choose Where to Open Your Roth IRA Roth IRAs can be opened with a variety of financial institutions, including banks, brokerage firms, and robo-advisors. When selecting a provider, consider factors such as:
- Fees: Look for low fees, including account fees, trading fees, and expense ratios on mutual funds or ETFs.
- Investment Options: Ensure a wide range of investment choices that align with your risk tolerance and investment goals.
- Ease of Use: Consider the platform's usability, customer service, and the availability of educational resources.
- Minimum Investment Requirements: Some providers require a minimum amount to open an account, while others do not.
Step 3: Gather Required Documents Be prepared to provide personal information and documentation, including:
- Social Security Number (SSN)
- Driver's license or other government-issued ID
- Employment information
- Bank account information for funding your account
Step 4: Fill Out the Application You can usually complete the application process online within a few minutes. You'll need to provide the information gathered in the previous step and make decisions about your account, such as naming beneficiaries.
Step 5: Fund Your Roth IRA Once your account is open, you need to fund it. You can do this by transferring money from your bank account, rolling over funds from another retirement account, or setting up a direct deposit. Decide how much you want to contribute, and remember that the IRS sets annual contribution limits.
Step 6: Choose Your Investments With your Roth IRA funded, it's time to choose how to invest your money. Your options might include stocks, bonds, mutual funds, ETFs, and more. If you're unsure where to start, consider speaking with a financial advisor or choosing a target-date fund, which automatically adjusts your asset allocation as you approach retirement.
Step 7: Set Up Regular Contributions Maximize your retirement savings by setting up regular contributions to your Roth IRA. Even small, consistent contributions can grow significantly over time thanks to compound interest. Try to contribute as much as you can up to the annual limit.
Funding Your Roth IRA
Before you can start managing your Roth IRA, you’ll need to first get the money into the account. How an IRA works depends largely on the broker type you’ve chosen. But whether you’ve selected an online broker, a robo-advisor app, or a local brokerage, there should be a setup in place that makes funding your account easy.
In addition to answering your questions about what is a Roth IRA, a broker should be able to tell you how the process works. Usually, you’ll be able to provide your bank’s routing number and your own account number and have the funds electronically transferred.
Are Roth IRAs Insured?
The Federal Deposit Insurance Corporation (FDIC) insures accounts at participating banks for up to $250,000 per depositor per account. This protection extends to IRAs and not 401(k)s, as long as the broker or bank you’ve chosen is FDIC-insured. Look for this branding either on the broker’s website or on a sticker in the window at a brick-and-mortar location.
But with any bank account, it’s important to pay close attention to that $250,000 limit. Your coverage is limited to $250,000 per depositor per location, so if your Roth account is nearing that limit, it might be time to diversify those funds across account types or financial institutions.
What Can You Contribute to a Roth IRA?
While a Roth IRA provides tax-free withdrawals at retirement, there are strict limits on contributions. This starts with what you can contribute. You can only contribute earned income to a Roth IRA. This includes wages, tips, commissions, self-employment income, and non-taxable combat pay.
The amount of your Roth contribution is also limited each year. For 2024, you can only contribute up to $7,000 to your Roth IRA, or $8,000 if you’re age 50 or over.
Who's Eligible for a Roth IRA?
Not everyone will be able to take advantage of the Roth IRA tax-free distributions at retirement. The IRS sets income limits for contributors. If you make above that amount in a tax year, you won’t be able to put money into your Roth IRA that year.
Like the Roth IRA contribution limit, the income limit adjusts from year to year. Currently, if you file separately and make more than $161,000 a year, you can’t contribute to a Roth IRA. If you’re married filing jointly, the income limit is $240,000 in 2024.
The 5-Year Rule
Since you contribute money with the expectation of tax-free withdrawals in retirement, there's a holding period requirement. The IRS mandates that you cannot take out all the money tax-free for five years.
It's important to note that not all funds will be taxed. You can withdraw your contributions tax-free at any time. However, you'll face penalties if you withdraw any investment earnings before five years or before reaching age 59½. Additionally, withdrawals before age 59½ are subject to penalties unless you have a disability.
Final Thoughts
If you want to know whether a Roth IRA makes sense for you, it’s important to understand the tax benefits and underlying rules for the account. If your employer offers a 401(k), you may want to weigh the tax-deferred features and any available employer matching of contributions against paying taxes on your Roth IRA contributions now for tax-free distributions later. We recommend working with a Certified Financial Planner® to best evaluate your individual circumstances and find the best retirement savings options for you.
Frequently Asked Questions
What is a Roth IRA?
A Roth IRA is a type of individual retirement account where contributions are made with after-tax dollars, allowing for tax-free withdrawals in retirement. This can offer a significant tax advantage, especially for those who expect to be in a higher tax bracket in the future.
How do you open and fund a Roth IRA?
You can open a Roth IRA through various platforms, including local and online brokers, as well as robo-advisors. Funding the account typically involves transferring money electronically from your bank, using your bank’s routing number and your account number.
What are the eligibility requirements and contribution limits for a Roth IRA?
Eligibility to contribute to a Roth IRA is subject to income limits set by the IRS, which may change annually. For 2024, the contribution limit is $7,000 for those under 50 and $8,000 if you're age 50 or older. Contributions can only be made with earned income, which includes wages, salaries, commissions, and self-employment income.
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CEO and co-founder of Retirable.
As a retirement income specialist at Northwestern Mutual, Tyler worked hands-on to help people define their goals, achieve financial independence, and enter retirement with peace of mind. Later, at Policygenius, Tyler expanded the company’s reach into new products, turning Policygenius into an industry-leading distributor of disability and P&C insurance. Tyler’s efforts helped more than 10,000 people find the insurance they needed.
Retirable combines Tyler’s passion for retirement planning with his experience growing scalable businesses, with the goal of giving every American personalized advice.
Understanding 401(k)s
401(k) Rules
Cashing Out your 401(k)
Understanding Roth 401(k)s
Roth IRA Basics
Share this advice
CEO and co-founder of Retirable.
As a retirement income specialist at Northwestern Mutual, Tyler worked hands-on to help people define their goals, achieve financial independence, and enter retirement with peace of mind. Later, at Policygenius, Tyler expanded the company’s reach into new products, turning Policygenius into an industry-leading distributor of disability and P&C insurance. Tyler’s efforts helped more than 10,000 people find the insurance they needed.
Retirable combines Tyler’s passion for retirement planning with his experience growing scalable businesses, with the goal of giving every American personalized advice.
