Are you wondering, “How does a Roth IRA work?”
Maybe you already have a Roth savings account. Or, maybe you’re trying to decide the best way to save for retirement, and feeling overwhelmed by all the options out there. Roth IRAs are a great way to invest in your future, but you need to know how they work in order to get the most out of one.
In this guide, we’ll walk you through everything you need to know about how to manage a Roth IRA. Keep reading so you can make the perfect investment in your future!
How Does a Roth IRA Work?
The Roth IRA is a kind of retirement account that comes with a tax advantage.
These special retirement accounts can be funded with income after taxes. This means that when you file your taxes each year, you don’t get to deduct your contributions to your retirement account. However, the benefit of this is that when you pull money out of your Roth IRA, you don’t owe any taxes on it.
Traditional IRAs offer a tax deduction up front, and Roths don’t. However, many people prefer a Roth IRA pre-tax, because it saves them money in the long run. Also, since you contribute your own money and no tax money to a Roth IRA account, you can take money from the contributions out of the account at any time with no penalty. You only have to pay if you withdraw the earnings from your contributions.
Because of this, a Roth is one of the most flexible kinds of retirement accounts. If you’re hoping to save for retirement but worried that you might need that money sooner rather than later, you can open a Roth. If a financially dire situation occurs, you can treat the Roth like a savings account and just pull out the same money that you put in.
Roth IRAs and Tax Brackets
Some of the Roth IRA benefits depend on what tax bracket you’re in. If you think your tax rate will be higher when you retire than it is right now, a Roth IRA makes the most sense. For example, if you’re new to your career and don’t make a lot of money yet, a Roth is a great way to save. The upfront tax deduction for you wouldn’t be much, and you’ll benefit by letting your money grow tax-free.
For many people, this is a great way to help children and grandchildren start planning for retirement. Opening a Roth IRA for a younger family member teaches them financial responsibility and the importance of planning for the future. Roth IRAs even allow older relatives to leave tax-free inheritances.
Roth Savings Eligibility
There are a few eligibility requirements for a Roth IRA account. Let’s see if you meet them.
First off are the income eligibility requirements. However, the income limit is higher than what the vast majority of Americans make, so chances are good that you qualify.
If your income is above the threshold, you can still convert assets from a traditional IRA to a Roth IRA. However, you’ll have to pay taxes on the amount you decide to convert.
Maximum Contribution Limits
There’s also a maximum amount you can contribute to a Roth IRA each year. Right now, that annual maximum is $5,500, as long as you’re single or are the single head of household. The income limit for contributing this much is $120,000 modified adjusted gross income.
If you’re married and file taxes jointly, the income limit grows to $189,000.
The maximum contribution can only be made if you earned that much or more over the year. For example, if you only made $3,000 in a year, you can’t contribute the full $5,500 to your Roth savings. You can only contribute up to $3,000.
However, if one spouse isn’t working, they can still contribute the full amount as a couple to each of their accounts, as long as the other spouse makes enough to cover that amount.
Partial Contribution Limits
If you can’t make the maximum contribution, you’re still allowed to make a partial contribution. This applies to people with a modified adjusted gross income between $120,000 and $135,000 (or $189,000 and $199,000 for married people who file jointly). If your income is above those limits, you’re not allowed to contribute anything to a Roth IRA.
Interestingly, if a married couple lives together but files separately, they may not be able to contribute to a Roth at all. Partial contributions are allowed for these couples, but only for the individuals who make less than $10,000 per year.
Roth IRA Benefits
Sounds pretty good so far, right? But there are a few more benefits to a Roth IRA pre-tax account that you may not know about.
1. Flexible Withdrawals
Unlike many types of retirement accounts, Roths offer you the flexibility to withdraw your contributions at any time without paying a tax or penalty.
If you want to withdraw the earnings, you will have to pay penalties, unless you’ve had the account at least five years and are age 59 1/2 or older. However, there are a few exceptions to this rule. For example, you can take out up to $10,000 if you’re buying a first home, even if some or all of that money was your earnings.
You can also withdraw earnings early to help pay for college for you or a family member.
2. No Required Withdrawals
Although you have flexible withdrawing options, you’re not required to take mandatory withdrawals. Traditional IRAs have mandatory withdrawals starting at 70 1/2 years of age. However, with a Roth, you can leave your balance and let it keep growing as long as you’d like.
3. Retirement Savings
If you’re still working after the age of retirement, you can keep contributing to your Roth savings account. You just have to be within the required income limits mentioned above.
Ready to Start Contributing?
You can contribute to your Roth IRA account each year on or before tax day. Now that you know the answer to “How does a Roth IRA work?”, why wait? Open an account now so you can start saving up for your future!
Want to learn how to invest the money in your Roth account wisely? Check out our beginner’s guide to investing!