Why save for retirement with a Roth IRA?
This article will take you through a Roth IRA (Individual Retirement Account) and help you determine if it’s the right retirement investment option for you.
Summary
A Roth IRA is a retirement savings account you can open and contribute after-tax income.
The IRS limits how much you can contribute to your Roth IRA each year.
There are multiple benefits to opening a Roth IRA.
A financial advisor can help you plan for retirement and ensure you’re on track to meet your goals.
What is a Roth IRA?
A Roth IRA is, in many ways, similar to a traditional IRA (Individual Retirement Account). Any person can open either type of IRA and begin contributing to it, and it isn’t in any way tied to their employer, unlike a 401(k).
The distinction between an IRA and a Roth IRA is how these accounts are taxed.
With a traditional IRA, contributions to the account are tax-deductible, but withdrawals will be taxed. With a Roth IRA, donations to the account are taxed, but withdrawals are tax-free.
It’s worth noting that these tax distinctions also distinguish a traditional 401(k) from a Roth 401(k).
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How does a Roth IRA work?
Put simply, you place after-tax income and earnings in a Roth IRA as you progress toward retirement. Then, you watch that money grow over time.
Then, when you’re ready to kickstart your years of rest and relaxation, you can make a qualified withdrawal from your Roth IRA without paying any further taxes or fees.
Regular monthly contributions are the most common way to build up the amount in your Roth IRA over time. Other funding sources include:
Conversions and transfers from previous retirement investment options.
Rollover contributions (similar to the above, rolling over savings from one account type to another).
Spousal contributions.
The Internal Revenue Service (IRS) limits how much you’re permitted to deposit each year, and this amount changes periodically – so you’ll need to keep an eye on it.
Generally speaking, a Roth IRA is less restrictive than a traditional IRA or a 401(k), with no minimum required number of distributions. That said, there are some limitations. For instance, single filers can’t contribute to a Roth IRA if they earn more than $153,000 annually, and fees may still apply if a withdrawal isn’t considered “qualified.”
If you’re considering opening this sort of account, you’ll need to thoroughly explore whether it will work for your particular financial situation, and a qualified financial advisor can help here.
Want to know how much you can get from your Roth IRA at retirement? Check out our free Roth IRA Calculator here>
Why invest in a Roth IRA?
There are multiple benefits to opening and investing in a Roth IRA, including:
Your money can grow tax-free once it’s in the account.
You can enjoy tax-free, penalty-free qualified withdrawals.
There’s no set number of required withdrawals/distributions.
You can pass tax-free money on to your beneficiaries after death.
There’s no age limit when opening a Roth IRA.
You may qualify for additional tax credits.
You may be able to invest in a Roth IRA and a 401(k), maximizing retirement savings.
Who are good Roth IRA providers?
Anyone with an earned income can open a Roth IRA at banks, brokerages, or financial institutions that offer retirement accounts.
They also need to have received IRS approval to offer this product.
What makes a good Roth IRA will depend on what you’re looking for, but factors such as fees and investment options should be considered.
Some of the most prominent and well-regarded Roth IRA providers include:
Charles Schwab
Vanguard
Interactive Brokers
Fidelity Investments
Betterment
If you’re considering opening a Roth IRA but unsure about your options, it’s best to speak to an expert financial advisor. They can guide you in the right direction and ensure you’re on the right track to achieve your retirement goals.
Unbiased can connect you with a financial advisor here.
How do I open a Roth IRA?
Not all Roth IRA providers will offer the same expansive list of investment options, so you’ll need to factor this in as you choose an institution to open your account with. Your risk tolerance and investment preferences will also play a significant role in your choice of provider, as will your ability to meet their account requirements. Some providers, for example, have a higher minimum account balance requirement than others.
You can open your Roth IRA at any age and time of year (though contributions for a specific tax year must be made by the relevant filing deadline). When you open your account, you’ll be provided with two documents:
Your IRA adoption agreement and plan document.
Your IRA disclosure statement.
How much can I contribute to a Roth IRA?
As mentioned above, the IRS limits how much you can contribute to your Roth IRA each tax year. As of 2023, most people can contribute a maximum of $6,500, an increase of $500 from 2022. Plus, using $1,000 in catch-up contributions, people aged 50 and over can contribute a maximum of $7,500.
We also briefly touched on the fact that you won’t be able to contribute to your Roth IRA if your earned income is over a certain threshold. In 2023, that’s $153,000 or over of adjusted gross income (AGI) for single filers and $228,000 for married couples filing jointly.
When can I withdraw from a Roth IRA?
One of the most significant benefits of a Roth IRA is that qualified withdrawals are tax-free and penalty-free. Rules associated with withdrawal will vary depending on how old you are and how long you’ve had the account. Keep in mind the following guidelines to avoid a ten percent early withdrawal fee:
Withdrawals from your Roth IRA must be made after a five-year holding period.
Withdrawals from your Roth IRA must be made after age 59 and a half.
Early withdrawal penalty exceptions exist in certain circumstances, including buying your first home, college expenses, and birth/adoption expenses.
What is the difference between a Roth IRA and a 401(k)?
A 401(k) is a retirement account for which employers match employees' contributions up to a certain amount. While an IRA (Roth or traditional) is an individual account, and the contributions are primarily your own, a 401(k) could see you double your retirement savings with the help of your employer. It could reduce your financial limitations.
There are many benefits to a 401(k), including higher annual contribution limits and easy-to-manage, employer-automated opt-in systems. That said, there are certain limitations, like early withdrawal penalties.
And most importantly:
A 401(k) depends on where you work and who employs you, while a Roth IRA does not. For many self-employed Americans and the 32 percent of employed Americans who don’t have access to employer-sponsored plans, a 401(k) is not available.
If you can access a 401(k), you might best maximize your retirement savings by opening a Roth IRA alongside it.
Get expert financial advice
For some advice on how to do just that or any other aspect of retirement planning that you might need help with, an experienced financial advisor is well-placed to assist.
If you’re ready to explore your retirement options, land on the right choices for you, and plan effectively.
Matching with a financial advisor perfectly suited to meet your needs is just a few clicks away.
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Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.