If federally tax-free retirement income sounds too good to be true, you'll want to learn about Roth IRAs. With a Roth IRA, you save and invest post-tax dollars and can enjoy tax-free qualified withdrawals1—including investment earnings—when you reach 59½ and the account has been funded at least 5 years from the beginning of the tax year of your first contribution.
If you like the sound of that, here's what you need to know about what Roth IRAs are, how they work, what benefits they can offer, and how to open one if you qualify.
What is a Roth IRA?
A Roth individual retirement account (IRA) is a retirement account that gives you a chance to grow your money over time by investing already-taxed dollars in a range of different securities, from stocks and bonds, to mutual funds, to exchange-traded funds (ETFs). The exact investment mix available will depend on your investing style and preference and what investment options are available through the financial institution where you opened the Roth IRA.
In retirement, your qualified withdrawals are tax-free—provided you satisfy a few basic rules.
How does a Roth IRA work?
The tax-free retirement income from a Roth IRA comes with a few strings attached. Before you invest, you'll need to know about 3 main topics: contribution, income, and withdrawal limits.
Roth IRA contribution limits
On paper, Roth IRAs and traditional IRAs share the same contribution limits in 2024: $7,000, or $8,000 for those 50 or older. However, how much you earn a year may reduce or eliminate your ability to contribute that amount to the Roth IRA.
Roth IRA income limits
Unlike a traditional IRA, which anyone with earned income can contribute to, your ability to contribute to a Roth IRA depends on your income, as shown by your modified adjusted gross income, or MAGI. MAGI is your adjusted gross income (aka your total income minus tax credits, adjustments, and deductions), with some of those credits, adjustments, and deductions added back in. Your MAGI and tax-filing status work together to determine whether you can make a full, partial, or no contribution to a Roth IRA for the tax year.
| Roth IRA income (MAGI) and contribution limits for 2024 | ||
|---|---|---|
| Filing status | Modified adjusted gross income (MAGI) | Contribution limit |
| Single individuals | < $146,000 | $7,000 |
| ≥ $146,000 but < $161,000 | Partial contribution | |
| ≥ $161,000 | Not eligible | |
| Married (filing joint returns) | < $230,000 | $7,000 |
| ≥ $230,000 but < $240,000 | Partial contribution | |
| ≥ $240,000 | Not eligible | |
| Married (filing separately)2 | < $10,000 | Partial contribution |
| ≥ $10,000 | Not eligible | |
Source: Internal Revenue Service, Notice 2023-75, November 2023.
These annual MAGI limits only apply to new contributions to a Roth IRA. So if you opened a Roth IRA in the past, you can keep the account open and still invest the balance. You just won't be able to make any additional contributions in years when your MAGI exceeds the IRS limits.
Another important thing to keep in mind: IRA contribution limits apply across all IRA types, so if you have both a traditional and Roth IRA, you can only contribute up to the annual maximum across both accounts each year, not the annual maximum in each. That means, for instance, that if your income limits you to a partial Roth IRA contribution, you could make up the difference using a traditional IRA up to the total IRA contribution limit for the year.
If you earn too much to save using a Roth IRA, you could have other ways to access the same tax-free growth potential. For instance, if your employer offers a Roth 401(k) option, you can get all the benefits of a Roth IRA without the income restrictions. Or you could use a strategy called a backdoor Roth IRA, a technique that lets high earners convert nondeductible contributions made to a traditional IRA into a Roth IRA.
Roth IRA withdrawal rules
Since you contribute after-tax money to a Roth IRA, you can withdraw your contributions at any time without taxes or penalties, even before retirement. For your investment gains, however, it's a different story.
| How Roth IRA withdrawals work | ||
|---|---|---|
| If you are... | And your Roth IRA has been funded for… | You can withdraw... |
| Under age 59½ | Any amount of time |
Earnings subject to tax and a 10% penalty
|
| 59½ and older | Less than 5 years from the beginning of the tax year of your first contribution |
Earnings subject to tax but no penalty
|
| 59½ and older | 5 years or more from the beginning of the tax year of your first contribution |
Earnings without taxes or penalty
|
Under certain circumstances, the IRS makes some exceptions to the 10% early withdrawal penalty. You can withdraw earnings penalty-free before 59½ and only be subject to income taxes if you use funds for:
- Qualified education expenses, such as college tuition
- Up to $5,000 for expenses for a birth or adoption
- For medical expenses or to pay for health insurance when you're unemployed
- Up to $10,000 to buy your first home
If you have inherited a Roth IRA, or plan to leave your Roth IRA to someone else, any gains can be withdrawn without penalty. However, you must keep in mind when the Roth IRA was opened. While these exclusions can save you from the 10% penalty, they may not save you from paying income tax on earnings if the account hasn't been funded for at least 5 years from the beginning of the tax year of the initial funding.
Roth IRA versus traditional IRA
The type of IRA you use to save for retirement often comes down to a question of whether you want to benefit from a tax break now (traditional IRAs) or later (Roth IRAs). To help you decide which one fits your retirement savings goals and tax situation, here are some of the benefits a Roth IRA can offer that may help you achieve those goals.
Tax-free retirement income
If your current income sets you up to be taxed at a lower rate than you expect you'll pay in retirement, or you simply value the certainty of knowing what you'll owe the government, it may make sense to lock in tax-free future qualified withdrawals now with a Roth IRA. While you won't get to deduct your contributions from your taxes today, like you would with a traditional IRA, you are eliminating the risk you have to pay more later on your contributions—plus any amount they've grown.
Flexible withdrawal rules
While it's generally intended to be a retirement account, a Roth IRA's withdrawal rules can help you access cash in a pinch. You're subject to taxes and penalties on traditional IRA withdrawals before age 59½. But Roth IRAs let you tap your contributions tax- and penalty-free at any time. There are no required minimum distributions (RMDs).
With traditional IRAs and other retirement accounts, the government forces you to begin withdrawals after you reach age 73—whether you need the money or not—through a mechanism called required minimum distributions (RMDs). If you don't take out the required amount, you could face a tax penalty. But Roth IRAs aren't subject to RMDs—if you're the original account owner and not an inheritor—which means you can stay invested as long as you'd like and continue to potentially grow your savings.
Create a legacy
If you want to leave your retirement savings behind, Roth IRAs offer a powerful way to transfer wealth tax-free. For instance, spousal beneficiaries receive the same beneficial tax treatment—tax-free growth and withdrawals—as the original account owner, as long as the Roth IRA is at least 5 years old when your beneficiaries begin withdrawals. This is especially important to consider as inherited IRAs now must be liquidated within 10 years for most nonspouse recipients, which can create a tricky tax situation for those receiving traditional, untaxed retirement accounts who then must pay taxes on their withdrawals.
How to open a Roth IRA
If you're ready to start saving for retirement with a Roth account, opening a Roth IRA only takes a few simple steps.
1. Choose a broker-dealer or investment company
You can compare fees and available securities at a wide range of broker-dealers or financial institutions offering Roth IRAs. Most brokerages even let you open a Roth IRA online.
2. Fund your Roth IRA
Funding your Roth IRA starts with contributing to it. But before contributing, it is important to ensure that you are eligible. Although the most common way to fund a Roth IRA is by contributing cash from your bank account, wire transfer, or ACH as an eligible yearly contribution, there are also ways to contribute via rollovers from other retirement accounts—these contributions may be treated as a conversion which is subject to immediate taxation. Financial maneuvers like these can be complicated, and it's best to consult a financial professional if considering.
3. Invest the money
Once the funds in your new Roth IRA are available, you can invest the money into any securities available at your broker-dealer or investment company. But remember—you don't have to go it alone. From online guides that can help you pick investments and free online financial planning tools to working with a financial professional, there's help on hand to empower you each step of the way.