Table of Contents
Key Takeaways
- Roth IRA Basics: It's a retirement account where you can invest in assets like stocks, bonds, mutual funds, and CDs.
- Contribution Limits: IRS sets annual limits - under 50, contribute up to $7,000; 50 or older, up to $8,000.
- Tax Benefits: Contributions are not tax-deductible, but it offers tax-free growth on investments and tax-free withdrawals in retirement.
- Eligibility: Income limits apply to determine eligibility for direct contributions.
- Withdrawal Rules: Best to wait until age 59 1/2; exceptions for penalty-free withdrawals include education, first home purchase, and health insurance premiums during unemployment or disability.
In our fast-paced world, we tend to want everything right now. But delayed gratification is one of the secrets to success. The same logic applies to retirement planning with a Roth individual retirement account (IRA). While such an account doesn't give you an immediate tax benefit, it does come with potential savings later in life.
Roth IRA Defined
A Roth IRA is a type of retirement account that you can open at many financial services companies and add money to throughout the year. You can invest the savings in a variety of assets, including stocks, bonds, mutual funds and certificates of deposit (CDs). The types of investment options will vary depending on where you open the account.
How Much Can You Contribute to a Roth IRA?
There are annual Roth IRA contribution limits, according to the IRS:
- up to $7,000 per year if you're younger than age 50
- up to $8,000 per year if you're age 50 or older
A Roth IRA is not a workplace retirement plan, which means you don't need an employer to set up this account on your behalf.
What Are the Tax Benefits of a Roth IRA?
You don't receive a tax deduction for adding money to a Roth IRA. Instead, this account saves your tax breaks for the future.
- Account delays taxes on your investment earnings. As long as you keep your money in your account, you will not owe income tax on your gains. If you had invested through a non-retirement account, you'd owe income tax on your gains every year — even if you reinvest the money right away.
- Retirement withdrawals from a Roth IRA are completely tax-free. This means you never owe income tax on your investment gains, as long as you are at least age 59 1/2 and have had the account for at least five years. A Roth IRA is one of the few ways to earn tax-free income in the U.S.
Who Can Contribute to a Roth IRA?
The government has Roth IRA income limits to determine who can use this type of account.1
- If you're single, you can only use a Roth IRA if your adjusted gross income (AGI) is less than $146,000.
- If you're married and filing jointly, you can only use a Roth IRA if your joint AGI is less than $230,000. You can also open a Roth IRA even if you have a retirement plan at work.
When Can You Withdraw From a Roth IRA?
Since a Roth IRA is a retirement plan, you're supposed to keep your money in the account until you turn age 59 1/2, which is the official IRA retirement age. If you need to take money out before then, you do have options.
Contributions tax-free
If you want to take out your investment earnings, you could owe income tax and an additional 10 percent early withdrawal penalty on whatever you take out. For example, if you have $150,000 in your Roth IRA ($100,000 in contributions and $50,000 in capital gains), you could take out $100,000 tax-free without any penalty. However, anything above that amount could be taxed and hit with the penalty.
Exceptions
While there is a penalty for taking money out before you turn age 59 1/2, there are a few exceptions to this if you use the money for:2
- College expenses
- Buy your first home
- Health insurance premiums when unemployed or became disabled
When Could a Roth IRA Make Sense?
A Roth IRA could make sense when you're younger. Since you have more time to grow your money, you'll likely earn more from your investments, which means you could earn more tax-free income.
The lower your tax bracket is now, the more a Roth IRA could also make sense. Other accounts, such as traditional IRAs or 401(k)s, give you an upfront tax deduction, but this is less valuable when you're in a lower tax bracket. You may benefit more from the tax-free income in retirement over the smaller tax deduction today.
Roth IRA could make sense if you think your tax bracket will increase when you retire. You're paying the taxes now versus later — when you'll potentially owe more. By considering this information, you can decide whether a Roth IRA might make sense for your retirement plan.
Sources
- 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000. https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000.
- Retirement Topics - Exceptions to Tax on Early Distributions. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions.
