What is a Roth IRA and How Can I Use It?
You’ve probably come across the term “Roth IRA” before, but what does it mean — and how can you use one? These retirement savings vehicles can be a powerful part of retirement planning if used in the right situation, but they aren’t foolproof.
Here’s what you need to know about Roth IRAs before you invest.
What’s a Roth?
IRAs are Individual Retirement Accounts, and there are two types: Traditional and Roth.
With a Roth IRA, your contributions are made with after-tax dollars and your distributions in retirement are tax-free.
In other words, you won’t get a tax break on your contributions today, but when you begin taking retirement income from your Roth IRA the income won’t be taxed at all.
With tax-free growth and distributions, you keep the gains from any growth in your account. You also get to decide if you even want to turn them into income — with a Roth IRA, there are no minimum distributions or requirements to take income from the account in retirement.
Roth IRAs can be particularly useful if you:
- Are young and expect your income to rise in the coming years
- Don’t expect that you’ll need to use your IRA for income in retirement
- Expect to be in a higher tax-bracket in retirement than you are now
- Have contributed to other retirement accounts already and can afford to save even more
How much can I contribute?
There are limits for Roth IRA accounts. To start, you can only contribute to a Roth IRA if you meet certain income requirements.1
|If you are…
||With an income of…
||You can contribute…
|Married filing jointly
Between $183,000 and $193,999
$194,000 and higher
Phased out depending on exact income
Between $117,000 and $131,999
Phased out depending on exact income
Keep in mind, though: there is a special bonus for those over age 50: an additional $1,000 “catch-up” contribution, which effectively raises the contribution limit to $6,500 (provided you meet the relevant income restrictions).
Another great feature? If you or your spouse don’t work, you can still set aside money in a Roth IRA based on the working partner’s income. That means you can still take steps towards maximizing your retirement planning — even if you’re out of the work force right now.
How do I access my money?
Because of their special tax benefits, there are rules in place about when you can withdraw your money and how.
In order to qualify for tax-free and penalty-free withdrawals:
- Your account must have been in place for at least 5 years before the withdrawal
- You have to be over the age of 59.5 or your distribution must be a result of death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum)
However, you don’t have to take distributions from your Roth IRA if you don’t want to: there are no Required Minimum Distributions in retirement on Roth accounts, meaning that you could leave the account alone and bequeath it to your heirs if you choose.
What are the risks?
Keep in mind that a Roth IRA is still an investment account and subject to the risks and rewards of any investment decisions that you make.
That means your account could still lose value if the investments you choose do not perform well.
Also, because of the tax rules, Roth IRAs are not appropriate for short-term savings or emergency funds. If you don’t have emergency savings, consider adjusting your financial plan so that you can plan for short-term needs without the risk of penalties or additional fees.
Who should have a Roth IRA?
Weighing up whether a Roth IRA is right for you requires careful consideration of the advantages and disadvantages of these accounts and how they might fit into the larger picture of your finances.
Consider the following questions:
- Do you expect your income to rise over the coming years and in retirement?
- Barring an emergency, can you restrict access to your savings for at least 5 years?
- Do you have other qualified retirement accounts or savings vehicles?
Remember, every financial situation is different — if you’re uncertain about whether a Roth IRA is right for you and your family, speak to a financial advisor who can help you navigate the options and make a plan that reflects your specific goals and needs.