Roth IRA

Name: Roth IRA
Item: Roth IRA
Author: Nathan Paulus

A Roth individual retirement arrangement (IRA) is a tax-advantaged investment that lets you contribute after-tax dollars and withdraw it later, tax-free if you meet certain conditions.

By Nathan Paulus

Updated: October 31, 2024

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What Is a Roth IRA?

A Roth IRA, which stands for a Roth individual retirement arrangement, is a tax-advantaged investment meant for retirement. With a Roth IRA account, you can contribute after-tax funds into the account and withdraw it at retirement age (59 ½), tax-free.

Roth IRAs are a flexible and liquid investment where you can choose to withdraw any of your funds after at least five years of opening your account without worrying about taxes. However, note that if you withdraw your funds earlier than planned, any profit or growth resulting from the investment will be taxed, and you may have to pay a penalty.

Having access to a Roth IRA is vital for the 33% of private industry workers who have no access to employer-provided retirement plans. It is a convenient way to plan and save for their expenses later in life. Even workers with workplace-based plans can take advantage of this investment, as it can serve as an extra retirement cushion.

A Roth IRA is a retirement investment account that lets you contribute after-tax dollars and withdraw tax-free.

You can withdraw from your Roth IRA account early and enjoy tax-free benefits, but any profit or growth will be taxed, and you may have to pay a 10% penalty.

The maximum contribution limit changes every year, but for most filers younger 50, the limit is $6,500, while for those older than 50, the limit is $7,500.

Single filers with a Modified Adjusted Gross Income (MAGI) of more than $144,000, married couples filing jointly or widow(er)s with a MAGI of more than $214,000, and married couples filing separately with a MAGI of $10,000 or greater cannot contribute to a Roth IRA account.

Most investment companies offer a Roth IRA.

Understanding Roth IRAs

A Roth IRA is a type of tax-advantaged investment meant for retirement. Contributions made to your account are from after-tax funds, and as a result, growth and withdrawals are tax-free. Anyone can open and contribute to a Roth IRA account up to a limit of $6,500 for 2023. The limit is $7,500 for those older than 50.

Being able to enjoy your retirement without worrying about taxes is one of the main benefits of a Roth IRA, but certain conditions apply. To enjoy tax-free withdrawals, you must have an account open for at least five years, and withdrawals should be made when you are at least 59 ½ years old. If you withdraw funds without meeting these conditions, the money you take out may be subject to a 10% tax penalty and income tax.

Roth IRAs are also similar to traditional IRAs, but there are differences in taxes, what you have access to and eligibility requirements. For instance, traditional IRA contributions are tax-deductible, lowering your taxable income for the year that you make contributions. However, when you retire or need cash from your account, anything you take will be taxed at your income tax rate at the time of withdrawal, which can benefit you if you expect to be in the same or a lower tax bracket when you retire.

Taxable Compensation

Not all types of income can be used to contribute to a Roth IRA, as contributions must come from earned income or taxable compensation. Taxable compensation includes wages, salaries, commissions, tips, bonuses or net income from self-employment. However, compensation from passive income, such as earnings or profits of property, interest and dividend income, pension or annuity income, are not counted and cannot be used to contribute to a Roth IRA.

Aside from your income source, Roth IRA contributions also depend on income amount, such as your modified adjusted gross income (MAGI).

Modified Adjusted Gross Income (AGI)

An individual's modified adjusted gross income (MAGI) is calculated after considering certain deductions and tax penalties. In terms of a Roth IRA, individuals with MAGIs over a specific level may limit how much they can contribute or whether they can contribute.

For the tax year 2023, the thresholds are as follows:

For individuals filing as single or as the head of the household, you can make limited contributions if your MAGI is at least $138,000 but no more than $153,000.
For married couples filing jointly or qualifying widow(er)s, you can make limited contributions if your MAGI is at least $218,000 but no more than $228,000.
For married couples filing separately, you can make limited contributions with a MAGI of more than zero, but no more than $10,000.

How to Open a Roth IRA

Opening a Roth IRA is beneficial for any individual to get a headstart on their retirement plan. Since there are no age limits for a Roth IRA, starting early can ensure that you maximize compound interest over the years. Fortunately, most investment companies offer Roth IRAs and make the process easy for anyone interested in opening an account.

Whether you’re a working professional looking to save for your golden years or a parent trying to help your child, review the steps below to see how to open a Roth IRA.

Make sure you’re eligible

The would-be account holder must have earned income or taxable income no more than the IRS’ MAGI limits to qualify for a Roth IRA. Single filers must have a MAGI below $144,000 to contribute the maximum amount of $6,500. Those married and filing jointly must have a MAGI below $218,000.

Decide where to open your account

Most investment companies offer Roth IRAs and Traditional IRAs, but not all offers are the same. For instance, some companies will require a fee to maintain your account, while others will only require payment to open it. You will also want to get a company that offers your desired investment vehicles and has excellent customer service.

Accomplish the forms given

Once you’ve chosen an investment company, review their application process. Most companies offer a way to open an account online, but if you’d like to speak to an agent, you can contact their help desk first. Before application, make sure to have a form of photo identification on hand, your Social Security number and your beneficiary’s details.

Choose where your Roth IRA goes

Your investment firm should let you decide how you want to invest the funds into your Roth IRA. While you can design your portfolio, you can also choose to have professionals at your investment company design it for you. Some firms offer various funds intended for specific risk appetites and time frames.

Start your contribution

Once your account is open, you can set up a contribution schedule or start sending in contributions right away. You can choose to contribute monthly, quarterly or even annually, so long as you contribute before the tax-filing date for the following year, typically April 15.

Amount of Roth IRA Contributions for 2024

How much you can contribute to your Roth IRA will depend on your filing status and your MAGI. Review the maximum contribution limits below to determine how much you can give based on your situation.

Filing Status	Modified Adjusted Gross Income (AGI)	Maximum Annual Contribution
Married filing jointly or qualifying widow(er)	< $218,000	Up to the limit imposed for 2023: $6,500 for under 50 years old $7,500 for those 50 and over
Married filing jointly or qualifying widow(er)	≥ $218,000 but < $228,000	A reduced amount
Married filing jointly or qualifying widow(er)	≥ $228,000	Zero
Married filing separately and you lived with your spouse at any time during the year	< $10,000	A reduced amount
Married filing separately and you lived with your spouse at any time during the year	≥ $10,000	Zero
Single, head of household, or married filing separately and you did not live with your spouse at any time during the year	< $138,000	Up to the limit imposed for 2023: $6,500 for under 50 years old $7,500 for those 50 and over
Single, head of household, or married filing separately and you did not live with your spouse at any time during the year	≥ $138,000 but < $153,000	A reduced amount
Single, head of household, or married filing separately and you did not live with your spouse at any time during the year	≥ $153,000	Zero

Source: Amount of Roth IRA Contributions That You Can Make for 2022, Internal Revenue Service (IRS)

Reduced IRA Contributions

While the typical contribution limit for a Roth IRA is $6,500, some individuals with a specific filing status or income level may have a reduced limit. To ensure that low- and middle-income earners continue to benefit from tax-advantaged accounts and prevent high-income earners from receiving an unfair advantage, the IRS limits the amount taxpayers can invest in Roth IRAs.

The IRS requires the following filers to have reduced contributions:

Single, head of household or married filing separately, and you did not live with your spouse at any time during the year.

Married filing jointly or qualifying widow(er).

Married filing separately, and you lived with your spouse at any time during the year.

Determining Your Reduced IRA Contribution

If you fall under a category that requires a reduced contribution limit, use the following steps to compute your contribution.

Calculate your Modified Annual Gross Income (MAGI)

Get the sum of your gross income from all sources, subtract any applicable “adjustments,” and add any deductions you qualify for. To find your applicable adjustments, you can find this on your IRS Form 1040 Schedule 1.

Subtract the following from your MAGI based on your filing status:

$204,000 if you’re filing a joint return or as a qualifying widow(er).
$-0- if married filing a separate return, and you lived with your spouse at any time during the year.
$129,000 for all other types of filers who have reduced contribution limits.

Divide the result from Step 2 by:

$10,000 for individuals filing a joint return, qualifying widow(er)s or individuals who are married but filing separately and have lived with their spouse at any time during the year.
$15,000 for all other filers.

Multiply the quotient in Step 3 by:

the maximum contribution limit before the reduction to any contributions.

Get the difference between the result in Step 4 & the maximum contribution limit before reduction

The result is your reduced contribution limit.

EXCESS CONTRIBUTIONS ARE SUBJECT TO EXCISE TAX!

If you go over your Roth IRA contribution, a 6% excise tax will apply to anything in excess of your limit. For instance, if you contribute $8,000 when you’re only allowed to contribute $6,500, you will have to pay $90 in excise tax.

Withdrawing Funds From Your Roth IRA

Roth IRAs have more flexible withdrawal rules than traditional IRAs, but some requirements and penalties can apply depending on your withdrawal purpose. Generally, there are two withdrawal types: qualified distributions and non-qualified distributions.

Qualified Distributions

A qualified distribution is a tax-free and penalty-free withdrawal, which typically requires that you meet the IRS’ requirements. To be counted as a qualified distribution, your Roth IRA account must have been active for at least five tax years, and your withdrawal must be:

Made on or after you turn 59 ½ years old
Taken due to a permanent disability
Requested by your estate or beneficiary after your death
Used to build or buy your first home (up to $10,000)

Non-Qualified Distributions

If the conditions for a qualified distribution are not met, it will count as a non-qualified distribution. This is where taxes or penalties can apply.

No taxes will apply if you withdraw from your contributions, but a 10% penalty applies. If you withdraw from your earnings, you will pay taxes on said earnings at an ordinary income tax rate and the 10% penalty.

However, the 10% penalty may be waived if your purpose for withdrawal falls under the following reasons:

You are taking a series of equal distributions
You have medical expenses, not eligible for reimbursement, exceeding 10% of your MAGI
You need to pay for health insurance premiums after suffering unemployment
You need it for an IRS levy
You are taking qualified reservist distributions
You need to pay for eligible education costs
You need to pay for childbirth or adoption up to $5,000

Withdrawal Examples

Understanding exactly how your withdrawal will work can help you determine when you should get funds from your Roth IRA. After all, you may find that your purpose falls under an exemption if you need to withdraw earlier than usual.

Example 1: Older Than 59 ½ & Ready to Retire

If you are older than 59 ½ years of age and have decided to retire, you can use your Roth IRA account funds. Further, a 62-year-old loved one can withdraw funds to help pay for their monthly expenses, such as bills or other leisure expenses. Simply withdrawing funds will not result in taxes or penalties, as you meet the IRS’ requirements and have already paid after-tax dollars.

Example 2: Have a Roth for More Than 5 Years & Need Funds for Childbirth

If a 32-year-old with a Roth IRA for more than five years needs funds for childbirth, then their desired funds will only have to undergo income taxation unless only contributions are withdrawn, but no 10% penalty.

However, if the same individual wants to withdraw to purchase an item or take a vacation, then any earnings from their withdrawal will be subjected to income tax, and they will have to pay a 10% penalty. For instance, if they withdraw $5,000 from their contributions, they will be subjected to a $500 fee.

Example 3: Having a Roth for More Than 5 Years & Paying for First Home

A 26-year-old individual who opened a Roth IRA at 21 to pay for their first home will be able to withdraw from their contributions and earnings up to a limit of $10,000. None of their withdrawals will be subjected to tax or a penalty, which means they will receive the whole of what they withdraw.

Roth IRA FAQs

A Roth IRA can be confusing, especially compared to its cousin, the traditional IRA. Review the most frequently asked questions below to gain clarity regarding the Roth IRA.

What’s the difference between Roth IRA and traditional IRA?

Both Roth IRAs and traditional IRAs are similar in that they offer tax advantages, but when you receive the tax advantage can differ. A traditional IRA’s contributions are tax-deductible, lowering your taxable income for that year, while a Roth IRA’s contributions are made after-tax. Withdrawals from a traditional IRA will also undergo income tax, while withdrawals from a Roth IRA are tax-free.

Can I convert my Roth IRA to traditional IRA?

No. The Tax Cuts and Jobs Act (TCJA) of 2017 prohibited the recharacterization of Roth IRA funds back into a traditional IRA. In other words, once you switch your traditional IRA to a Roth IRA, the change is irrevocable.

Can I set up a Roth IRA for my spouse?

To open a Roth IRA, you need to have earned income. If your spouse has earned income, you can open an account in their name. Otherwise, you may want to opt for a spousal IRA, which lets you contribute in your spouse’s name even if they do not have a job.

Where can I open a Roth IRA?

Most investment companies and brokerage firms have Roth IRAs, so it should be a matter of finding the best company for your needs.

How much does it cost to open a Roth IRA?

The cost to open a Roth IRA will depend on the investment company of your choice, as companies may charge no fee while others will. Instead, you may be required to make a minimum deposit.