What is a Roth IRA?
A Roth IRA is an individual retirement account in which money grows tax-free and withdrawals in retirement are tax-free.
People at least 59½ years old and who hold their accounts for at least five years can take distributions, including earnings, without paying federal taxes.
Understanding how a Roth IRA works
Here's an overview to help you understand the basics of a Roth IRA.
You invest the money in the account. A Roth IRA is an individual retirement account that holds your investments, rather than an investment itself. You can lose money or you can make money in a Roth IRA. What you earn and whether you lose money depends on how you invest.
You open a Roth IRA at a brokerage or bank. Then you select what you want to invest in, such as mutual funds, stocks, bonds, exchange-traded funds (ETFs) or bank savings products. For a long-term goal like retirement, we recommend investing in stocks and bonds because of their higher returns. That means opening your Roth at a brokerage or robo-advisor rather than at a bank. Here's more on how to invest your IRA.
You can add money to it over time. You can contribute one lump sum or make smaller contributions over the course of the year, as long as your contributions don't exceed $6,000 ($7,000 if you're 50 or older) or your taxable compensation, whichever is smaller. (That's the maximum annual contribution in 2020.) You can also add money to a Roth by rolling over money from another retirement account.
Your contributions aren't tax-deductible. Unlike with traditional IRAs, you don't get a tax deduction for contributing to a Roth IRA.
Withdrawals are tax-free, though. In general, you can withdraw your contributions without owing penalties or taxes (you've already paid taxes on the money you put in).
» Ready to begin? Learn how to open a Roth
Who is eligible for a Roth IRA?
Here are the basic rules and qualifications.
You have to have earned income. To contribute to a Roth or traditional IRA, you must have income from work (the IRS term is "taxable compensation"). The maximum annual contribution is your income from work or $6,000 ($7,000 if you're age 50 or older), whichever is less.
You must be under the income limit. The amount you can contribute to a Roth IRA begins to shrink at certain thresholds for modified adjusted gross income, and keeps shrinking as income rises, until your ability to contribute is eliminated completely. (The backdoor Roth strategy offers a workaround — more on that below.)
Note: The income limits apply to your modified adjusted gross income (MAGI), which is your adjusted gross income with some deductions and exclusions added back in. (See IRS Publication 590-A, Worksheet 2-1, for complete instructions on figuring MAGI for Roth IRAs.)
Roth IRA income limits for 2020 contributions
For more details on Roth IRA limits and the exceptions to them, see our IRA limits page.
How to open a Roth IRA
Most online brokers, banks and robo-advisors offer Roth IRAs.
Banks. Because most banks offer access to savings vehicles (like CDs), rather than investments, they are generally not the best place to open an IRA, which should be geared toward long-term growth.
Robo-advisors. A good first step in the Roth IRA shopping process is deciding whether you want to take a hands-off approach to investing — in which case a robo-advisor and its automated investment process might be appealing — or a more active approach to choosing your investments, which might make a traditional broker more attractive.
Here are some of our top picks for best Roth IRA accounts:
» Want the deep dive? Here are all of our top picks for the best Roth IRA accounts
Roth IRA withdrawal rules
Here are three things to remember.
You can withdraw your original contributions whenever you want, without owing any penalties or taxes, no matter how long your account has been open. That's because the money you put in is money you already paid income tax on.
When you withdraw money from a Roth IRA, the IRS always assumes your original contributions come out first.
Qualified withdrawals of investment earnings in the account come out tax-free. However, in certain circumstances the IRS may want a piece of those returns, in the form of taxes and a possible penalty, if you withdrawal early or otherwise don’t meet the rules for a qualified withdrawal.
» Check out our easy explainer on Roth IRA withdrawal rules
Advantages and benefits of a Roth IRA
Roth IRAs are worth it if you expect your tax rate to be higher in the future. That’s because you contribute money now that you'll pay income taxes on this year. That is, you don't get a tax break on your contributions — with a Roth, the tax break comes later. If your tax rate is lower now, it makes sense to pay taxes now in return for tax-free retirement withdrawals. But even if you're not sure about your future tax bill, opening a Roth IRA can be a smart move for other reasons.
Easy withdrawals. You can withdraw the money you contributed any time, without taxes or penalty. (You may be taxed or penalized if you withdraw investment earnings.)
Double dipping. You can contribute to a Roth in addition to a 401(k). In 2019 and 2020, the Roth limit is $6,000 per year ($7,000 if you’re 50 or older), up from $5,500 and $6,500 in 2018.
Flexible timing. You can choose when you contribute to a Roth IRA, and how much you contribute, up to the annual maximum. For example, you could contribute $6,000 on the first day of the year, or split up your contributions over many months.
Extra time to contribute. You have until the tax deadline to contribute for the previous calendar year.
Tax-free distributions. Once you hit 59½ and have held the account for at least five years, you can take distributions, including earnings, from a Roth IRA without paying federal taxes.
No age limit to open. You can open a Roth IRA at any age, as long as you have earned income (you can’t contribute more than your earned income).
No RMDs. Roth IRAs aren't subject to the required minimum distributions required from a traditional IRA or 401(k) starting at age 72 (in 2019 and earlier years, that age was 70½).
Roth IRA vs. traditional IRA
The bottom line is this: If you want an immediate tax break, consider a traditional IRA. If you like the idea of tax-free income in retirement, a Roth IRA is a good idea.
Roth IRAs are a smart savings tool for young people just starting out, because they’re likely to face higher income tax rates as they move along in their career.
Someone further along on their career path may also like a Roth IRA, because they provide tax-free income in retirement. That provides what some financial advisors call "tax diversification."
Money stashed in accounts, such as 401(k)s and traditional IRAs, leads to tax bills in retirement. A Roth IRA can offer a convenient way to manage that tax bill; for example, by pulling at least some income from the Roth to avoid being pushed into a higher tax bracket.