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What Is a Roth IRA? How to Get Started

Roth IRAs are retirement accounts that offer valuable tax benefits, including tax-free growth on your investments.

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What is a Roth IRA?

A Roth IRA is a retirement account that encourages you to save by offering a tax benefit: Your money grows tax-free, and there's no tax on your Roth IRA withdrawals in retirement. A traditional IRA is different: You may be eligible to take a tax deduction on your contributions in the year you put the money in, and then your withdrawals in retirement are taxed as income.

Roth IRAs are a great retirement-savings account 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. Read on to find out how Roths work and what their benefits are.

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How does a Roth IRA work?

Like a traditional IRA, a Roth IRA is an account that holds your investments, rather than an investment itself. You open a Roth IRA at a brokerage or bank, then select what you want to invest in, such as mutual funds, stocks, bonds, exchange-traded funds (ETFs) or bank savings products.

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 both 2020 and 2019.)

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.

» Ready to begin? Learn how to open a Roth

What are the benefits of a Roth IRA?

  • You can withdraw the money you contributed any time, without taxes or penalty. (You may be taxed or penalized if you withdraw investment earnings.)

  • 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.

  • 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.

  • You have until the tax deadline to contribute. April 15, 2020 is the deadline to contribute for 2019.

  • 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.

  • 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).

  • Roth IRAs aren't subject to the required minimum distributions required from a traditional IRA or 401(k) starting at age 70½. This means you can use a Roth to pass money to your heirs.

roth ira

Am I eligible for a Roth IRA?

To contribute to a Roth or traditional IRA, you must have income from work (the IRS term is "taxable compensation"). The maximum annual contribution in both 2020 and 2019 is $6,000 ($7,000 if you're age 50 or older) or your income from work, whichever is less.

One downside: You won’t be eligible for a Roth if you earn too much. 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 2019 and 2020

For more details on Roth IRA limits and the exceptions to them, see our IRA limits page.

Backdoor Roth IRAs

An interesting thing about Roth IRAs is that there's a relatively easy way to sidestep the income limits and fund a Roth anyway. High earners can use the backdoor Roth IRA strategy to get their money into a Roth.

The strategy entails opening a traditional IRA, and then converting that money to a Roth IRA. There's no limit on how much you can convert, but you may face a big tax bill if you have a lot of pre-tax money in your traditional IRA accounts. When figuring your tax bill on a conversion from a traditional to a Roth IRA, the IRS will look at all of your traditional IRA accounts combined.

For example, if your traditional IRAs add up to 70% pre-tax money and 30% after-tax money, that ratio determines what percentage of the money you convert to a Roth will be taxable. In this example, no matter how much money you convert or which IRA account you pull the money from, 70% of the amount you convert to the Roth will be taxable. A word about timing: the IRS applies the pro-rata rule to your total IRA balance at year-end, not at the time of conversion.

Spousal Roth IRAs

Remember how we said you have to have money from work to contribute to a Roth? There is one exception to that rule: For a married couple that files their taxes jointly, if one spouse isn’t working for pay, that spouse can contribute to a spousal IRA, as long as that spouse’s contributions and the working spouse’s contributions, added together, don’t exceed the couple’s taxable compensation for the year.

That means, as long as the working spouse's taxable compensation is at least $12,000, each spouse can contribute $6,000 to each of their respective accounts. Or, if both spouses are 50 or older and compensation is $14,000 or more, each spouse can contribute $7,000.

The spousal IRA is in the non-working spouse's name and is just like any traditional or Roth IRA. Read more about spousal IRAs.

Opening a Roth IRA

Most online brokers, banks and robo-advisors offer Roth IRAs. 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.

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.

Two of NerdWallet’s highest-ranked providers for hands-off Roth IRA management are Wealthfront and Betterment. Robo-advisors use computer algorithms to offer investment plans tailored to your goals and time horizon, all for a fraction of the cost of traditional investment advisors.

Two of NerdWallet’s top picks for conventional Roth IRA brokerages are TD Ameritrade and Merrill Edge. These brokers appear in NerdWallet’s rankings because of their low costs, large selection of mutual funds and no account minimums.

» Want the deep dive? Here are all of our top picks for the best Roth IRA accounts

Roth IRA withdrawal rules

The rules that govern Roth IRA withdrawals can be confusing, but there's one easy to thing to remember: You can always withdraw your contributions — the money you put into the account — 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. The IRS is fine with you pulling it back out any time. Also, when you withdraw money from a Roth IRA, the IRS always assumes your contributions come out first.

But the IRS will want a piece of any investment returns you earn on the money in your account, in the form of income taxes and possibly an early withdrawal penalty. But — and here's where it can get a bit confusing — there are a handful of exceptions to those rules, which make it possible to withdraw even your investment earnings without penalty.

» Check out our easy explainer on Roth IRA withdrawal rules

Roth IRA vs. traditional IRA

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.

But even someone who is further along on their career path may like a Roth IRA, because these accounts provide tax-free income in retirement. That opportunity for tax-free income provides what some financial advisors call "tax diversification."

Many retirees have money stashed in accounts, such as 401(k)s and traditional IRAs, which lead 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.

But 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.

More Roth IRA questions? We've got answers

Unlike a bank savings account, a Roth IRA doesn’t come with a fixed interest rate. How much money you earn in your Roth will depend on what you invest in. While it is possible to invest your Roth IRA in fixed-income vehicles, such as certificates of deposit, if your retirement is a decade or more away, we recommend investing a significant part of your Roth in the stock market. That’s because the stock market’s average return has historically been far higher than the returns on bonds, bank savings accounts and similar less-risky investments.

If you're wondering how to choose investments for your Roth IRA, check out our three stress-free ideas for investing. To see how small differences in returns add up over time, check out our Roth IRA calculator.

Roth IRAs and 401(k)s are both valuable retirement savings plans, and the good news is, you can contribute to both if you want.

No matter what, if your 401(k) offers an employer match, be sure to invest enough in the 401(k) to get the full match. That's free money you don't want to ignore.

Then the question is: How good is your 401(k)? If your workplace plan offers solid investment choices at a low cost — think mutual fund expense ratios of about 0.5% or less — then that’s a smart place to invest. If your 401(k) plan isn’t great — maybe it’s expensive, or the lineup of investments isn’t good — then it makes sense to max out a Roth IRA or a traditional IRA, because you’ll generally be able to find a wide range of low-cost investments at a broker. (Check out our list of top-rated brokers for Roth IRAs for some low-cost options.)

Another question is: Do you want to get a tax break now, or later? A 401(k) is like a traditional IRA: You put money in before paying taxes on it — you get your tax break upfront — and your money grows tax-deferred until retirement, at which point you pay income tax on your contributions and investment earnings when you pull the money out.

With a Roth IRA and a Roth 401(k), you put money in after having paid income tax on it, and then your money grows tax-free and comes out entirely tax-free in retirement, assuming you follow the rules. Here’s more on how to choose between an IRA and a 401(k).

The Roth IRA contribution limit in 2018 was $5,500, or $6,500 if age 50 or older. (In 2019 and 2020, you can contribute up to $6,000, or $7,000 if 50 or older). But there is a deadline to contribute, and it's the tax filing deadline, which generally falls on April 15. That is, April 15, 2019 was the last day to contribute to a traditional or Roth IRA for 2018. (SEP IRAs are an exception: You can contribute all the way through mid-October if you file an extension.)

If you transfer your 401(k) money to a Roth IRA, you’ll likely owe income tax on the entire amount you move over — unless your money is in a Roth 401(k). Plus, moving a lump sum of pre-tax money into an after-tax account like that may bump you into a higher tax bracket, possibly leading to a higher-than-expected tax bill.

If you’re eager to move your 401(k) to an IRA, then consider a rollover IRA. A rollover IRA is a traditional IRA. Like a 401(k), traditional IRAs hold pre-tax money. If you roll your money over from a 401(k) to a traditional IRA, you won’t get a tax bill for the rollover, as long as you follow the rollover rules.

Depending on what you invest your Roth IRA money in, you may, at times, see the value of your account dip. That’s especially true if you invest in the stock market. But despite that volatility, investors who stick with stocks for the long haul are able to ride out the dips and watch their money grow at average returns exceeding just about any other investment.

The key is to make sure your investments are diversified. If that seems like a task you don’t want to deal with, then consider the benefits of a robo-advisor — it will pick a diversified portfolio for you.

There are many advantages to a Roth IRA, but nothing’s perfect. Here are a couple of disadvantages to consider:

--You can’t take a loan from an IRA the way you can with many 401(k)s. That said, you can always withdraw your Roth IRA contributions anytime without penalty, interest or taxes. --Early withdrawals (before age 59½) of your investment earnings come with a 10% penalty unless you meet one of a handful of exceptions.

Whether $1 million is enough for a comfortable retirement will depend on your lifestyle, location and life expectancy. Half of Americans (50%) believe $1 million is enough to retire on, while 31% say it would not be enough, according to a NerdWallet survey, conducted online by The Harris Poll, of more than 2,000 U.S. adults in June 2018. Nineteen percent are not sure if it is enough.

Overall, only 32% of Americans say they’re confident they’ll have enough money saved for retirement by their desired retirement age based on their current rate of savings. Making use of tax-advantaged retirement accounts — including workplace retirement plans and a Roth IRA — can help you join that group.

Use a retirement calculator to get a personalized goal, then motivate yourself to reach it. One fun way to do that is to figure out when your nest egg will hit that $1 million mark. You can use the calculator below to estimate when you’ll unlock the seven-figure badge.

METHODOLOGY

This survey was conducted online within the United States by The Harris Poll on behalf of NerdWallet from June 14-18, 2018, among 2,024 U.S. adults ages 18 and older. This online survey is not based on a probability sample and therefore no estimate of theoretical sampling error can be calculated.