What is a Roth IRA?

A Roth IRA is a type of individual retirement account (IRA) that allows retirement savers to contribute money on an after-tax basis. Money grows tax-free inside of the account and can be withdrawn tax-free if certain requirements are met.

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How does a Roth IRA work?

Contributions are made to a Roth IRA with after-tax dollars. There is no upfront tax break; however if certain requirements are met, the money can be withdrawn tax-free. While the money is in the Roth IRA it grows tax-free.

Check out some of the articles on the Empower (formerly Personal Capital) site for more on the workings of a Roth IRA.

Roth IRA contribution rules and limits

There are annual contribution limits for both traditional and Roth IRAs. The annual limit is combined across all IRA accounts and types, which means if you have one of each account type, you still cannot contribute more than the annual contribution limits.

The IRA contribution limits for 2023 and 2024 are:

Contributions for a given tax year can be made up to the tax filing date, with no extensions. Contributions for the 2023 tax year can be made up to April 15, 2024 and contributions for the 2024 tax year up to April 15, 2025.

In order to contribute to a Roth IRA, your income must be under the income limits for the year.

Who qualifies for a Roth IRA?

In order to be able to contribute to any type of IRA, including a Roth IRA you need to have earned income from employment or self-employment. Interest or investment income and pension income doesn’t count.

The income limits to be able to contribute to a Roth IRA are based on a taxpayer’s modified adjusted gross income (AGI). The income limits for 2023 and 2024 are:

Spousal Roth IRA

In the case of a married couple, a spousal Roth IRA can be opened for a non-working spouse. The couple must file as “married filing jointly” to qualify.

In this case, a married couple could each contribute the maximum to a Roth IRA if so desired. For 2024 this would be $7,000 each, plus an additional $1,000 if either or both are 50 or over. The working spouse must have earned income and each spouse may not contribute more than that earned income amount. The income limitations outlined above will also apply.

Rollovers

Another way to fund a Roth IRA is to roll over a Roth 401(k), Roth 403(b) or other type of Roth account from a workplace retirement plan. This is most often done in association with someone who is leaving that employer to switch jobs, because they are retiring or due to being terminated from employment.

You will want to coordinate the rollover between the IRA custodian who will be receiving the funds and the plan that you are rolling the money over from. There are no income or contribution limits associated with this type of rollover, and there should not be any tax implications.

Roth conversions

A Roth IRA conversion allows you to convert assets held in a traditional IRA, a traditional 401(k) or similar workplace retirement account to a Roth IRA. Taxes will be due on some or all of the amount converted. The advantage here is that this allows the account holder to convert a higher amount than the annual IRA contribution limits. It also allows those who earn too much to contribute to a Roth IRA to still fund a Roth IRA.

Backdoor Roth IRAs

A backdoor Roth IRA involves contributing to a traditional IRA on an after-tax basis and then converting that money to a Roth IRA. This is a way for high earners who cannot contribute directly to a Roth IRA to still fund an account. The amount of the conversion may be tax-free or subject to taxes based on the pro-rata rule. This rule says that the conversion will be taxed based on the ratio of tax-free contributions to pre-tax contributions and account earnings across all traditional IRAs.

Mega backdoor Roth

If offered by your employer, you may be able to make after-tax contributions over and above the annual employee contribution limit for a 401(k). You can then convert this money to a Roth 401(k) option within the plan or to a Roth IRA upon leaving the company, or during your employment if your company allows this. This is another way for those who are ineligible to contribute to a Roth IRA to still fund one.

Roth IRA pros and cons

There are both pros and cons to a Roth IRA. Some of the pros include:

• The ability to withdraw money tax-free if certain requirements are met.
• No required minimum distributions must be taken.
• Money grows tax-free inside of the Roth IRA.
• Money in inherited Roth IRAs can be withdrawn tax-free if the account owner meets the five-year rule prior to their death.

Roth IRA cons include:

• Contributions are made with after-tax funds, there is no upfront tax break.
• The ability to contribute can be limited or eliminated if your income is too high.

How to open a Roth IRA

Roth IRA accounts can be opened at traditional brokerage firms like Fidelity, Schwab, Vanguard, Empower and others. You can then invest your account in most or all of the investments offered by the firm such as stocks, bonds, ETFs and mutual funds.

Many banks and credit unions offer Roth IRAs, but your investment choices may be limited there. Robo advisors also generally offer Roth IRAs, you would invest based on the strategy suggested by the Robo’s investment algorithm.

You will generally have to complete any required form(s) for the financial institution at which you are looking to open the Roth IRA. You will be required to supply certain information about yourself. Whether or not required upon opening the account, you will want to name beneficiaries of the account as soon as possible.

Withdrawals (a.k.a. qualified and non-qualified distributions)

Withdrawals from a Roth IRA are tax-free as long as they meet the criteria for a qualified withdrawal. Note that you can withdraw your original contributions to a Roth IRA tax and penalty-free at any time.

Qualified distributions

Qualified withdrawals from a Roth IRA are tax-free and there are no penalties. In order for the withdrawal to be classified as a qualified distribution, the five-year rule on the account must be met. This rule says that at least five years must have elapsed since the first contribution to the account. Additionally, any Roth IRA conversions have their own five-year rule.

In addition to meeting the five-year rule requirement, the withdrawal must meet at least one of these conditions:

• The Roth IRA account holder is at least age 59½.
• The distribution is due to the disability of the account holder.
• The distribution is made to the beneficiaries of the Roth IRA after the account holder’s death.
• Or it meets the requirements listed under the first time home buyer exemption for the account holder or a member of their immediate family.

Non-qualified distributions

Non-qualified Roth IRA distributions are those that do not meet the criteria to be classified as a qualified distribution. Non-qualified distributions may be subject to taxes and a 10% penalty. Note that any amount of the distribution attributable to the amount originally contributed to the Roth IRA will not be taxed or subject to penalties.

For those who are over 59 ½, distributions that have not met the five-year rule will be subject to taxes but not a 10% penalty.

For those who are under age 59 ½, withdrawals will be subject to both taxes and a 10% penalty. There are some exceptions that will eliminate the 10% penalty, but not the taxes on earnings in the account:

• The distribution is due to the disability of the account holder.
• You receive the distribution as the beneficiary of a deceased account owner.
• The distribution meets the requirements listed under the first time home buyer exemption for the account holder or a member of their immediate family.
• The distribution is taken as a series of substantially equal periodic payments.
• The distribution is taken to cover unreimbursed medical expenses in excess of 10% of your adjusted gross income (AGI).
• To pay medical insurance premiums if you are unemployed.
• To cover qualified higher educational expenses.
• The distribution is used to cover an IRS levy.
• The distribution is for a qualified military reservist.

Roth IRA vs. traditional IRA

There are several key differences to know between a Roth IRA and a traditional IRA account.

Contributions to a Roth IRA are made with after-tax dollars, in other words this is money that you have already paid taxes on. By contrast contributions to a traditional IRA are made with pre-tax dollars offering an upfront tax break. Note in some cases traditional IRA contributions are made on an after tax basis.

Withdrawals from a Roth IRA are made tax-free if the requirements for a qualified distribution are met. Withdrawals from a traditional IRA are generally taxed at the taxpayer’s ordinary income tax rate, with the exception of any funds tied to after-tax contributions.

Another key difference is that Roth IRAs are not subject to required minimum distributions while traditional IRAs are.

The ability to contribute to a Roth IRA can be limited or prohibited if your income is too high. There are income limitations on the ability to contribute to a traditional IRA on a pre-tax basis for those who are covered by a workplace retirement plan, like a 401(k). However, you can always contribute up to the annual contribution limits to a traditional IRA on an after-tax basis.

Frequently asked questions (FAQs)

How much do you need to open a Roth IRA?

There is no minimum required to open a Roth IRA account, unless the custodian (brokerage firm, financial institution or robo advisor) has their own requirement to open the account. If opening a new Roth IRA you will want to check with the custodian regarding any minimums or other new account requirements.

Can you withdraw money from a Roth IRA?

Money can be withdrawn from a Roth IRA at any time. Your contributions to the account will not be subject to taxes or penalties. Beyond that, the rules for qualified and non-qualified distributions outlined above will apply.

Do you pay taxes on a Roth IRA?

Your contributions to the account will not be subject to taxes or penalties. Beyond that, the rules for qualified and non-qualified distributions outlined above will apply.

What is better: a Roth 401(k) or a Roth IRA?

Both types of accounts have merit. With a Roth 401(k) there are no income restrictions on your ability to contribute as with a Roth IRA. Also the annual contribution limits on a Roth 401(k) are higher.

The main downside to a Roth 401(k) can be the quality of the investments offered in the plan. You will generally have more investment flexibility with a Roth IRA.