What is a Roth IRA?
A Roth IRA is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement. Roth IRA rules dictate that as long as you’ve owned your account for 5 years and you’re age 59½ or older, you can withdraw your money when you want to and you won’t owe any federal taxes.
How Does a Roth IRA Work?
Contributions to a Roth IRA are made with after-tax dollars. This means you’ve already paid taxes on the money you put into your Roth IRA. The benefit of this is that, unlike traditional IRAs, distributions from Roth IRAs are tax-free in retirement.
Withdrawals from a Roth IRA can be made tax-free, as long as they are considered qualified. Qualified distributions are those that meet the following requirements: the account has been open for at least five years, and the distribution is:
- Taken because you’re at least 59½
- Made because you are disabled
- Used to pay for a first-time home purchase
- Taken by a beneficiary or estate after your death
The IRS sets limits on how much you can contribute to a Roth IRA each year, based on your income level. For 2021, the maximum contribution is $6,000, or $7,000 if you’re age 50 or older.
Benefits of a Roth IRA
Tax-Free Growth and Withdrawals
The main advantage of a Roth IRA is that you get tax-free growth and tax-free withdrawals in retirement. This can be a significant benefit if you expect to be in a higher tax bracket in retirement than you are now.
No Required Minimum Distributions
Unlike traditional IRAs, Roth IRAs do not require you to start taking distributions at a certain age. This means you can leave your money in your Roth IRA as long as you like, allowing it to continue growing tax-free.
Roth IRAs offer more flexibility than traditional IRAs. For example, you can withdraw your contributions (but not any earnings on your contributions) at any time, for any reason, without having to pay taxes or penalties.
Who Can Contribute to a Roth IRA?
Not everyone is eligible to contribute to a Roth IRA. The IRS has income limits for Roth IRA contributions. For 2021, if you’re single, you can contribute to a Roth IRA if your modified adjusted gross income is less than $140,000. If you’re married and filing jointly, you can contribute if your modified adjusted gross income is less than $208,000.
How to Open a Roth IRA
Opening a Roth IRA is a straightforward process. You can open a Roth IRA at any financial institution that offers IRAs, and you can usually do it online. You’ll need to provide some personal information, choose your investments, and make a contribution to get started.