What is a Roth IRA and How to Open One

InvestingIRAs

Mar 14

In a world filled with diverse investment options to fund your retirement, countless choices can help you reach your goals. Examples include 401(k) accounts, health savings accounts (HSAs), EFTs, and even real estate. Each of these are smart options, depending on your own unique situation. Today, we’ll cover another retirement investment avenue—Roth IRAs—to help you decide if this path is right for you.

What is a Roth IRA, and how does it work?

As with a traditional IRA, a Roth IRA is an account specifically designed to help fund your retirement. You can invest in many different types of assets within the account including stocks, bonds, ETFs, and mutual funds.

However, unlike with traditional IRAs wherein tax breaks are often immediate (if funding with pre-tax dollars), Roth IRA tax breaks come later as contributions are typically made with after-tax dollars.

Why choose a Roth IRA?

The largest benefits accompanying a Roth IRA are tax-related, as your money grows tax-free and you can generally make tax and penalty-free withdrawals after turning 59½. These tax benefits are very appealing to investors, especially those (most of us) who find it difficult (if not impossible) to predict what their tax bracket will look like during retirement. More specifically, these breaks help you diversify your retirement income via both tax-deferred and tax-free accounts.

A Roth IRA is also sometimes an excellent wealth-transfer vehicle, allowing you to pass on any amount to your heirs—tax-free!

Moreover, can withdraw contributions at any time tax- and penalty-free—which is sometimes beneficial if you’re struggling to make ends meet or need the funds for a temporary expense. Just note, however, that this only applies to contributions; if you withdraw earnings before you’re eligible to make a qualified withdrawal, you’ll likely be required to pay taxes and face a 10% early-withdrawal penalty on the same (more on that shortly).

Required minimum distributions (RMDs), meanwhile, are the amount of money specified by the IRS that you must withdraw from your account. Unlike its traditional IRA counterpart, a Roth IRA isn’t subject to any RMD rules—meaning you don’t need to make withdrawals at any point during your lifetime.

Roth IRA contribution limits

As with many retirement accounts, you’ll need to adhere to several Roth IRA rules. One such example is contribution limits, meaning you can’t just add any amount of money to the account.

Roth IRAs feature the same contribution limits as traditional IRAs. If you’re under 50 years of age, the maximum annual contribution limit is $7,000 for 2024 (limits do change annually). Those age 50 or older can contribute up to $8,000 in 2024.

The extra $1,000 for this older age group is referred to as a “catch-up” contribution, offered by the IRS to encourage savings and help ease the financial burden of retirement: especially for those who failed to save enough when they were younger. This amount will likely be tweaked annually to accommodate cost-of-living adjustments.

You can also continue to make contributions for the previous year up until the income tax deadline (e.g., any amount up to the limit until April 15, 2024 for 2023).

Roth IRA income limits

Though you can contribute to a traditional IRA regardless of how much money you earn, this isn’t the case with Roth IRAs—which boast much stricter income limits.

For example, if you’re a single filer with a modified adjusted gross income (MAGI) exceeding $161,000 in 2024, you’re not eligible to contribute to a Roth IRA. Moreover, if your MAGI is more than $146,000 but less than $161,000, you can only contribute a reduced amount. Those who earn $146,000 or less in 2024, meanwhile, can do so for the full amount.

For those filing jointly, the maximum MAGI limit is $230,000 based on contribution qualifications. If your joint MAGI is more than $230,000 but less than $240,000, your maximum allowed annual contribution is reduced. Finally, couples earning less than $230,000 can contribute the full amount.

If you’re a higher-income earner (exceeding these income thresholds), you can still contribute to a Roth IRA but must do so through an IRS-approved method referred to as a “backdoor IRA.” There are several ways to create this, each of which requires converting a portion of (or all) traditional IRA funds to a Roth.

Roth IRA penalties

Roth IRA withdrawal penalty rules vary depending on your age, the specifics of your withdrawal, and how long you’ve had the account.

With Roth IRAs, you can withdraw sums equivalent to contributions you’ve made both penalty and tax-free—anytime and for any reason. If you’re over the age of 59½ and want to withdraw from the earnings portion of the account, you can do so tax-free—provided you’ve owned the account for at least five years (known as the “five-year rule”).

Withdraw from the earnings portion of your Roth IRA any earlier, and you may face a 10% early-withdrawal penalty and be required to pay taxes on these earnings. That said, there are exceptions to every rule; Roth IRAs are no different.

For example, anyone who’s owned a Roth IRA for more than five years and is younger than 59½ can often avoid early-withdrawal penalties and taxes in various situations including:

· Using the withdrawal to fund a first-time home purchase (up to $10,000)

· Your estate or beneficiary withdraws the money after your death (if you’ve held the account for less than five years)

If you’ve had your Roth IRA for less than five years and are younger than 59½, you can avoid the early-withdrawal penalty (but are still subject to taxes) if:

· You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed

· You use the withdrawal to pay for qualified education expenses

· You use the withdrawal to fund a first-time home purchase (up to $10,000)

· You use funds for qualified expenses related to a birth or adoption

· Your estate or beneficiary withdraws the money after your death (if you’ve held the account for less than five years)

· You make the distribution in substantially equal periodic payments (otherwise known as a “SEPP”)

Note that the SECURE Act 2.0 has expanded these circumstances to include emergency expenses and domestic abuse.

If you’re age 59½ or older and owned your Roth IRA for less than five years, you’ll owe income tax but won’t need to pay a penalty on earnings you withdraw.

Where to open a Roth IRA

You can do so at almost any bank, credit union, or other financial institution, knowing that the former two options will most likely take shape as an IRA Certificate of Deposit (CD)—often a good option for people who want to minimize risk and guarantee their return.

You can also open a Roth IRA through your financial advisor or online brokerage, thus enjoying the ability to choose your investments and potentially see higher returns (albeit with more risk).

Just note you must generally have  earned income—such as wages, salaries, and/or other taxable employee compensation—to open and contribute to a Roth IRA. 

Other considerations

The retirement savings contributions credit—or “saver’s credit”—is designed to encourage people with low-to-moderate incomes to save for retirement, essentially offering a tax credit of up to $1,000 ($2,000 for married couples) just for contributing to a qualified retirement account (including a Roth IRA).

As with traditional IRAs, you are prohibited from using your Roth IRA to take out a loan—unlike other retirement vehicles such as a 401(k).

In sum: choosing a Roth IRA

How can you determine if a Roth IRA is right for you? Generally speaking, this option makes the most sense if you want more flexibility in withdrawing funds (contributions) in the absence of penalties, don’t want to worry about RMDs during retirement, and/or want to diversify your retirement savings so you can draw from both tax-free and taxable accounts.

Have questions about how a Roth IRA fits into your overall investments? Schedule a FREE Discovery call with one of our financial advisors.

FAQs

The specific amount can vary depending on the provider you choose. While many have no minimum requirement—allowing you to open an IRA with as little as $0—how much you should contribute to your IRA will ultimately depend on your own unique financial situation and goals.
As with any investment, this is in fact possible due to market volatility, poor investment decisions, early withdrawal and investment fees, or a combination of these.
A traditional IRA is a tax-deferred account, meaning you’ll pay taxes on a future date. These contributions are typically funded with pre-tax dollars, and earnings grow tax-deferred until they’re withdrawn in retirement. 
With a Roth IRA, on the other hand, contributions are made using after-tax money; this can then grow tax-free, and you won’t pay taxes on withdrawals made during retirement—assuming the account is at least five years old.
A mega backdoor Roth strategy allows individuals to contribute up to an additional $43,500 (for a total of $66,000, or $73,500 for those aged 50+) of 2024 after-tax dollars to a Roth IRA and/or Roth 401(k). However, this strategy isn’t available to everyone given a few requirements you can read about in an article we recently published.
Roth IRA heirs must generally follow the same rules as those who inherit a traditional IRA, meaning that designated beneficiaries—those who aren’t a spouse, minor child of the deceased owner, chronically ill or disabled, or more than 10 years younger than the account owner—must follow the 10-year rule.
This rule requires heirs to withdraw funds from the inherited account within 10 years of the IRA owner’s death (e.g., if a Roth IRA owner passes away in 2024, inherited IRA funds must be fully distributed by December 31, 2034).
If you’re the sole beneficiary of your spouse’s Roth IRA, you can read about your options in this regard.
Contributions in excess of annual Roth limits can trigger a penalty from the IRS, but you are allowed to backtrack. If you’ve already filed, you can remove the excess and earnings within six months and file an amended tax return; those who haven’t already filed can withdraw the excess contributions and earnings received on them. Either scenario requires you to pay taxes on earnings, but you won’t encounter a penalty. Another option is to reduce the following year’s contribution by the excess amount; however, you’ll pay a 6% penalty on the excess contributed for every year it remains in the account.
Due to the SECURE Act 2.0, individuals older than 70½ can now continue making IRA account contributions provided they’ve earned income. The impetus behind this measure is to incentivize those working later in life to save additional money and continue to build their nest egg over a longer period of time.