What is a Roth IRA? A Beginner’s Guide

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If your goal is to save for retirement, you may be considering opening an IRA – an Individual Retirement Account. Once the funds go into your Roth IRA account you can choose to invest in stocks, ETFs, gold, silver, bonds, mutual funds, and more. A Roth IRA is one of the best options for many individuals, but there is often much confusion about what it is and how it works.

So, what is a Roth IRA and how can you open one with better terms? Our experts will answer these questions and more, so you have all the information you need to open a Roth IRA account.

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What is a Roth IRA?

What is a Roth IRA and why was it created? Let’s start by defining exactly what a Roth IRA is.

The Roth IRA account was introduced in 1997 by former Delaware Senator William Roth – hence its name. This retirement account is designed to offer special tax benefits, such as tax-free growth and withdrawals if certain requirements are met.

While other qualified retirement plans also allow the money to grow tax-deferred, the Roth is unique because you will never be taxed on the distributions as long as you meet all the conditions. It is also much less restrictive since you can contribute at any age if you have earned income, there are no required minimum distributions (RMDs), and you can access a wide range of investments.

Benefits of a Roth IRA

Many individual investors choose to open a Roth IRA account because of the many benefits they offer. These include access to special tax benefits, enhancing your retirement savings, no age restrictions, and added flexibility.

Access Tax Benefits

The most obvious benefit of Roth IRAs is that they allow you to invest tax-free. Since you pay the taxes on the money you are contributing now, you won’t need to in the future. This is ideal for investors who are in a lower tax bracket right now and expect to be pay at higher rates down the road.

After you turn age 59 ½, and you have had a Roth IRA account for at least five years, all your distributions are tax-free. That means you never have to pay taxes on the money that was earned in the account!

Likewise, you don't have to worry about taking RMDs, or required minimum distributions, like are required for 401(k)s and Traditional IRAs.

Enhance Your Retirement Savings Plan

Another benefit of opening a Roth IRA is that it allows you to enhance your retirement savings. The Roth IRA contribution limits are separate from what you can save in your 401(k), so you can boost your total investment each year.

In other words, you can contribute to both a Roth IRA and a 401(k), which allows you to add as much as you can to your retirement savings. The Roth IRA is also unique because you have extra time to fund the account – you can add money to your Roth for the previous year up until the tax deadline.

No Age Restrictions

There are no age restrictions to funding a Roth IRA account. You can open one at any age too, so long as you have earned income. While you can’t contribute more to the account than your total earned income – and you are still subject to contribution limits – it is a great option for those that can no longer add money to other types of accounts because of their age.

Flexible Timing and Withdrawals

Roth IRAs also offer flexible timing of contributions and withdrawals. There is no minimum to how much you can contribute to your Roth – and you can choose to deposit the entire amount on day one or split them up throughout the year.

Withdraws are also simple, as you can take out any money you have without penalty or taxes. You will be penalized if you access the earnings before age 59 ½, but this is still more flexible than other options available for retirement savings.

Roth IRA Drawbacks

Even though there are many benefits to opening a Roth IRA account, there are also some drawbacks that you should consider. For example, you must think about the early withdrawal penalty and the fact that you cannot take any loans from the account.

Early Withdrawal Penalty

The primary drawback to investing in a Roth IRA is that there is an early withdrawal penalty. You can only access your investment earnings when you reach age 59 ½, otherwise, you will be subject to a 10% penalty.

There are a handful of exceptions to this rule, but, in general, your earnings will be penalized if you withdraw them from the account too soon.

No Loan Options

Another downside to Roth IRAs is that they do not offer any loan options. Many 401(k)s allow participants to borrow from the money they have saved – they can simply repay the loan over time.

On the other hand, you cannot take a loan from an IRA.

How Does a Roth IRA Work? Key Takeaways

Now that you understand the basics of what a Roth IRA is, let's dive into how they work.

Like with other retirement accounts, a Roth IRA allows you to invest money for your retirement, but you do not have to pay taxes on the earnings. Since you will never be subject to taxes on these earnings if you meet all the requirements, you cannot deduct any contributions made to the account on your current tax return.

Rather than getting a tax benefit today, a Roth IRA allows you to access potentially greater tax savings by letting your earnings grow tax-free indefinitely. These qualified distributions can be made once you reach age 59 ½ and meet the 5-year rule – otherwise, you may be subject to taxes and penalties.

Roth IRAs are less restrictive because you can leave the funds in the account as long as you live. There are no RMDs like you would experience with traditional IRAs and 401(k)s. This makes it a great option for investors who do not want to be forced to withdraw their funds when they reach age 72.

Roth IRA Example

For example, let’s imagine that you contribute $6,000 to a Roth IRA in your early 20’s. This money will be invested, and you can direct the trading strategy – so you can work to grow the value as much as possible. Since Roth IRA contributions are made with after-tax funds, though, you cannot deduct this on your tax return.

Once you turn 59 ½, you can withdraw all the funds in the account without paying any taxes. So, if your account grew to be $100,000 by that time, you made $94,000 tax-free!

Understanding the 5-Year Rule

To truly understand how a Roth IRA works, it is essential to review the 5-year rule. This is a special rule that applies to Roth IRA accounts and determines whether your earnings will be subject to taxes or the 10% penalty.

As you may have guessed, your Roth IRA must have been opened for at least 5 years to meet the 5-year rule. When you meet this condition, any time withdrawals made after age 59 ½ will be tax- and penalty-free.

So, what happens if you don't meet the 5-year rule? In this scenario, your earnings will be subject to taxes when you take distributions even if you meet the standard age requirements. That also means you will need to pay the 10% penalty any time you make a withdrawal before age 59 ½.

Is a Roth IRA Different than Other IRAs?

Roth IRAs are different than the other individual retirement accounts you can choose from. You must consider the differences between a Roth account and a Traditional IRA, SEP IRA, and Simple IRA.

If you need a tax break right away, consider some of the other individual retirement account options first. The Roth IRA is different because though you make after-tax contributions, the income you draw from the earnings will be tax-free in retirement.

Any funds in other IRAs will be subject to taxes when you make a distribution. That means the cost of a tax deduction that year is to pay taxes on the contributions and earnings in the future.

It is important to note that while you can contribute to both a Traditional and Roth IRA in the same year, the contribution limit is combined. In other words, you can only contribute $6,000 (or $7,000 with the catch-up) in total across both account types.

Here is a comparison of all the different IRA accounts:

IRA
Account
20201 Contribution Limits Catch-Up Contribution Contribution Type Who Contributes to the IRA?

Roth IRA

$6,000

$1,000

After-Tax

Individual

Traditional IRA

$6,000

$1,000

Pre-Tax

Individual

SEP IRA

Lesser of 25% of Compensation or $58,000

N/A

Pre-Tax

Employer

Simple IRA

$13,500

$3,000

Pre-Tax

Employee & Employer

Roth IRA Contribution Limits in 2024

As you develop your investment and tax strategy, it is essential to consider the Roth IRA contribution limits. You can add up to $6,000 each year to your Roth IRA as the 2023 tax year. If you are age 50 or older, you can make an additional catch-up contribution of $1,000. That brings your total limit to $7,000 per year.

However, this eligibility is based on your modified adjusted gross income or MAGI. Your filing status will also affect these limits, so if you earn above a certain range, you may only be able to make partial contributions – or none altogether.

Use this chart to help determine what your allowable contribution might be:

Tax Filing Status MAGI Contribution Limit
Married Filing Joint or Qualifying Widow Less than $198,000 Full Contribution
Between $198,000 and $208,000 Reduced Contribution
Over $208,000 No Contribution
Married Filing Separately

(lived together)
Less than $10,000 Reduced Contribution
Over $10,000 No Contribution
Single, Head of Household

or Married Filing Separately

(lived separately)
Less than $125,000 Full Contribution
Between $125,000 and $140,000 Reduced Contribution
Over $140,000 No Contribution

You have until the tax deadline of April 15th to make your contribution for the previous tax year. If you file before this day, your contribution deadline is the day you file your taxes.

We recommend that you work with a tax professional like a CPA to determine exactly how much you can contribute to your Roth IRA each year. There may be penalties associated with over-contributing to your account, so you must calculate your allowable amount ahead of time.

If you are above the MAGI income limits and cannot contribute directly to a Roth IRA, you can consider a Back Door Roth. This involves making a non-deductible contribution to a Traditional IRA, then converting it to a Roth IRA.

Conversions cannot be recharacterized or reversed back into a Traditional IRA. That's why it is key to partner with a professional that can help you understand the Roth IRA contribution limits.

What Kind of Funds Can You Contribute to a Roth IRA?

Not all income can be contributed to a Roth IRA. There are certain sources of funds that you can contribute to the account, but others that you cannot – so let's review these requirements.

What You Can Contribute

You can contribute earned income to your Roth IRA. Earned income refers to money made by working for an employer, such as wages, commissions, salaries, bonuses, and more. Generally, this is reported on your W-2 tax form.

Other allowable sources include income from self-employment, like what is reported on a 1099. Likewise, you can contribute money from alimony, child support, and divorce-related proceeds.

You can also fund Roth IRAs through spousal contributions, transfers from other IRAs, rollover contributions, and conversions.

These contributions must all be made in cash – you can’t directly contribute assets or other securities. Once the funds go into your Roth IRA account you can choose to invest in stocks, ETFs, bonds, mutual funds, and more.

What You Can’t Contribute

If you do not have any earned income or have a spouse that does, you cannot contribute to a Roth IRA.

That means even if you are getting income from rental properties, interest on investments, annuity payments, or stock dividends, those funds are not eligible to go into your Roth IRA.

Similarly, you can never add more to your Roth IRA than you earned during that tax year. If you only earned $2,000 throughout the year, then that is your total allowable contribution.

Spousal IRA Rules

IRAs have special spousal rules that allow individuals to contribute to a Roth IRA account even if they do not have earned income. A spouse may contribute to the Roth IRA on behalf of their partner even if they have little or no income.

To do this, the couple must file a married, joint tax return. Likewise, the person contributing must have earned income and comply with the total contribution limits per their tax bracket.

Although each Roth IRA must follow the individual contribution limits, it essentially allows for a couple to double their annual savings – even if one is not working!

Can I Apply for a Roth IRA?

You can apply for a Roth IRA if you have earned income or are eligible under the spousal rules. Anyone can open these accounts if they meet the conditions since there is no age requirement. The most crucial considerations are the income limits, though, as you must be under that amount to contribute.

Where Can You Open a Roth IRA Account?

You can open a Roth IRA anywhere that has received approval from the IRS to offer that type of account. That means you can choose from a brokerage firm, banks, and more.

Stock Brokerage Firms

Many investors choose to open a Roth IRA through a traditional broker. Doing so allows you to have a more active approach to managing your investments, as you can directly control what your retirement account is invested in.

Banks

Although you can often open IRAs at the bank, it is not necessarily the best option for most investors. They typically only offer savings vehicles, such as CDs and money market accounts, so you do not have access to investments like stocks, ETFs, and mutual funds that offer better return potential.

Other Options

Robo-advisors are another option for opening a Roth IRA. These platforms offer a hands-off approach and allow for automated investing. While this can be appealing to some investors, take care to consider fees and limitations to the investment strategy.

Which IRA Account is the Best?

When it comes to choosing a platform for your Roth IRA, we recommend Webull. There are many reasons we suggest using Webull, including the fact that they offer no-commission trades on US stocks, ETFs, and more.

There is also no cost to set up the Roth IRA, and many other platforms charge a nominal fee of $30-$40. They also do not limit the stocks and ETFs you can purchase in the account, which is an added benefit.

The platform offers robust research and investment tools, so you can leverage technical indicators, charts, analyst reports, and more to drive your investment strategy. The 20 indicators they provide are much more than most other free trading platforms!

How to Open a Roth IRA Account

To open a Roth IRA account, all you need to do is follow these simple steps:

Choose your Roth IRA Broker

Many different brokers and platforms offer Roth IRAs, so the first step is to choose where you would like to open the account. It is important to consider fees, asset classes available, and research tools that you will have access to – which is why we will use Webull as an example.

Open an Account on Their Platform

Next, you must visit the broker’s website and register for an account. This involves providing identifying information like your name, address, date of birth, SSN, and more. Webull makes this process easy by allowing you to provide everything online – just choose Roth IRA when it asks you what type of account you would like to open.

Make a Contribution

Once the account is opened and verified, the last step is to contribute. This will allow you to start investing and grow your retirement savings!

Should I Open a Roth IRA?

There are many factors to consider when deciding if you should open a Roth IRA.

For starters, consider your unique tax situation. If you need a tax break today, it may not make sense to open a Roth IRA – you should instead explore the benefits of a Traditional IRA or another qualified account that provides an immediate tax deduction. Plus, if you are in a very high tax bracket, you may not be eligible to contribute to a Roth IRA anyway.

If you are willing to pay taxes on your contributions upfront, though, you will be greatly rewarded by having tax-free withdrawals on the earnings in the future. This makes sense if you are in a lower tax bracket now than you might be in the future.

These accounts also offer greater flexibility than 401(k)s in terms of investments, as most employers only offer a limited selection of mutual funds. If your goal is to execute a specific investment strategy that includes stocks and ETFs, then a Roth IRA is an ideal solution.

Most young investors and lower-income workers will benefit the most from Roth IRAs. However, anyone who wishes to access tax-free income in retirement should consider opening a Roth IRA account.

Summary

Roth IRAs are unique retirement accounts that allow you to pay the taxes on your contributions now, in exchange for all future distributions being tax-free. This is ideal for investors that think their tax rate will be higher during retirement when compared to their current tax bracket, and for young investors who have time on their side.

However, there are some restrictions to funding Roth IRA accounts. For instance, you can only contribute up to $6,000 each year – or $7,000 if you are age 50 or older. There are also income limits that may decrease the amount you can add to it each year.

Similarly, you must have the account open for at least 5 years before taking tax-free withdrawals – and the 59 ½ age requirement applies as it does to all qualified retirement accounts.

You can open a Roth IRA account at almost all brokerage firms, like an online trading platform. That includes investment companies and banks, too.

FAQs

What Are the Benefits of a Roth IRA?

Roth IRAs are a great way to save money for retirement – you can make after-tax contributions and direct the investments yourself. If you meet the conditions, all the earnings can be distributed tax-free, and you do not have to take RMDs.

How Much Can You Contribute to a Roth IRA?

In general, you can contribute up to $6,000 per year, or $7,000 if you are age 50 or older. However, there are MAGI income limits that can affect your allowable contributions.

Can You Buy Stocks in a Roth IRA?

Once your funds are in the Roth IRA, you can choose how to invest it – that means you can buy stocks, ETFs, and more!

Where is the Best Place to Open a Roth IRA?

Webull is one of the best brokers to open your Roth IRA account with. They offer zero commission trades, a wide variety of asset types, and extensive research tools so that you can maximize your returns and improve your investment strategy.

Team that worked on the article

Bruce Powers
Contributor

Bruce Powers is an expert trader and technical analyst with over 20 years of experience in Forex, commodities, ETFs, cryptocurrencies and other assets. He is an active trader, technical and fundamental analyst, media commentator, educator and a writer. As an author for Traders Union, he contributes his deep analytical skills, expertise and understanding of the global economy and financial markets to provide market analysis and insights. Powers is also a frequent guest on business TV news shows.

Bruce Powers’ professional experience:

• Expert trader and technical analyst with over 20 years of experience.
• Experience with Forex, gold and other commodities, equities, indices, ETFs, and cryptocurrencies.
• Spent 7 years as a trading and technical analysis course instructor, webinar leader, and educational content creator for a leading global training company.
• Led multiple FX/crypto live trading analysis and Webinar educational presentations.
• Experienced and active trader (equities, crypto, forex), technical analyst, fundamental analyst, media commentator, writer, and educator.
• Certified Chartered Market Technician (CMT) and MBA in finance.
• Published hundreds of technical analysis articles and other financial and economic articles.
• Appeared over 150 times as a guest on business TV news shows.

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Education
Eller College of Management, University of Arizona
Master of Business Administration (MBA), Finance

Dr. BJ Johnson
Dr. BJ Johnson
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Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.

The topics he covers include trading signals, cryptocurrencies, Forex brokers, stock brokers, expert advisors, binary options. He has also worked on the ratings of brokers and many other materials.

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Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.