Traditionally, retirement savings accounts have been offered as a perk of employment. But you don’t have to rely on an employer to set money aside for later. An individual retirement account (IRA) can help you invest in an account designed specifically for funding your retirement.

There are two types of IRAs: Traditional and Roth. Like a 401(k), a Traditional IRA lets you put money in before taxes are taken out on it. On the other hand is the Roth IRA. With a Roth IRA, you put the money in after you’ve paid taxes on it.

What is a Roth IRA?

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 to ease the tax burden in retirement. They lock in the certainty of taxes that 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.

Opening a Roth IRA

The next step in understanding what’s an IRA is finding out how to get one. You have a variety of options for setting up an IRA, from local and online brokers to do-it-yourself robo-advisors.

It’s important to understand that part of the Roth IRA definition is that your money will be invested in various assets. That means once you’ve deposited your funds, you’ll need to select your investments. Typically, independent brokers and advisors that offer Roth IRAs have far more investment options than what an employer-based retirement plan may offer. If you choose a robo-advisor or broker, you can rely on someone else to manage them, but you’ll still need to monitor it. That makes it even more important to choose the Roth IRA broker that best suits your preferences.

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 2021, you can only contribute up to $6,000 to your Roth IRA, or $7,000 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 $140,000 a year, you can’t contribute to a Roth IRA. If you’re married filing jointly, the income limit is $208,000 in 2021.

The 5-Year Rule

In addition to determining what’s a Roth IRA, you’ll also need to learn the rules specific to them. Since you put your money in with the understanding you won’t pay taxes on withdrawals in retirement, there’s a holding period requirement. The IRS won’t let you take all the money out, tax-free, for five years.

But it’s important to note that not all the funds will be taxed. You can withdraw the amount you contributed tax-free. If you take any of the money that is investment growth within the account, though, you’ll face penalties. In addition to the 5-year rule, you also can’t take the funds out without penalty until you’re aged 59½ 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.

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