Find The Best Insurance
We make it easy to compare and buy insurance.LEARN MORE
Funded by after-tax dollars, this retirement savings account will give you a source of tax-free income in the future.
If you’re saving for retirement you may have heard about the Roth IRA or even been advised to open one, likely due to its tax incentives. A Roth IRA is a retirement savings account funded with your after-tax dollars, so you won’t have to pay taxes on the money you withdraw in the future, if you’ve followed the contribution guidelines.
Roth IRAs offer flexibility with investment options and you can keep the account open indefinitely. The tax advantages can greatly benefit you, especially if you retire into a higher tax bracket, which is common for many people, as they delay retirement and continue to work.
For the 2019 tax year, the maximum annual contribution limit is $6,000 for those under age 50, and $7,000 for those 50 years-old and up.
In this article:
A Roth IRA, or individual retirement account, is an alternative to a work-sponsored retirement account, like a 401(k) or 403(b).You’ll have to open and contribute to a Roth IRA on your own. (More on that later.)
Contributions to a Roth IRA are made with after-tax dollars — you’ll make your contribution amount with income that’s already been taxed, according to your income tax bracket designated by the IRS. Unlike a traditional IRA or a standard 401(k), which is funded by pre-tax dollars, contributions to a Roth IRA are not tax-deductible.
However, because you’ve already paid income tax on your Roth contribution, the money in your Roth IRA will grow tax-free. That means you’ll have a stream of tax-free income in retirement.
For example, if you make an annual contribution of $5,000 for thirty years with a 4% rate of return, your Roth account balance will be $303,000.
You can also bequeath your Roth IRA to your heirs, who will receive it free of income tax, or name a trust the beneficiary.
With a Roth IRA, you can actually withdraw contributions at any time without any financial repercussions — but withdrawing any earnings could result in fees or penalty based on your age and how long you’ve had the account. Withdrawing from a Roth IRA is calling taking a distribution.
For example, if you’re younger than 59 ½ years old and owned the account for less than five years, you may have to pay both income taxes and a 10% additional penalty on any withdrawn earnings.
There are some exceptions that allow you to withdraw your earnings before age 59 ½ without penalties, such as a withdrawal for a first-time purchase of a house, a qualified education expense, or a disability-related withdrawal.
You can open a Roth IRA at a bank, credit union, an asset-management company, or online brokerage.
In order to open a Roth IRA, you must meet a few income eligibility requirements. The income levels are based on modified adjusted gross income( (MAGI).
If your income surpasses the levels listed above, you can make a partial contribution according to the following:
If your earnings exceed even these income limits, you may still be able to contribute to a Roth IRA account through a backdoor Roth, or a once-per-year conversion from a traditional IRA.
Annual contributions are capped for both traditional and Roth IRAs across all accounts. For the 2019 tax year, the IRA contribution limits are $6,000 if you’re under 50 years old, and $7,000 if you’re 50 years old and over. You can contribute to a Roth at any age, as long as you meet the income qualifications, unlike the traditional IRA, which can’t be contributed to after you’re 70½ years old.
Your contribution amount can only be as much as your earned income. For example, if your earned income for the year was $4,000, then you can only contribute $4,000 at maximum .
If you’re higher-income earner making a partial contribution, you can calculate the exact reduced amount you are allowed to give from the IRS’s own formula.
Contribute to your Roth IRA account through any of the following:
A Roth IRA doesn’t have a fixed interest rate. Instead, how much your Roth IRA earns depends on your investments. When your assets increase in value, you’ll get a higher return on your investment.
Your Roth IRA might not automatically make investments for you, so you’ll have to choose which securities to purchase, otherwise your money will gain only a small amount of interest by sitting in the account. A Roth IRA’s flexible investment options include:
Investments made with your Roth IRA may fluctuate, and could even lose money. Some types of investments are riskier than others; bonds are low risk, while stocks have a higher risk. But, because your retirement is years away, you should be able to recoup these losses in the long run.
Based on your risk tolerance,(how much you’re willing to lose), you should diversify your portfolio, or spread out the risk among investment types, either by yourself, through a financial planner, or even through a robo-adviser that invests your money based on algorithms. Offered by newer online brokerages, this automated process might appeal to people who prefer a hands off approach to investing.
Policygenius is partnering with Wealthfront to help you invest in your future.
The biggest advantage of having a Roth IRA are the tax-free withdrawals. If you follow the guidelines, after age 59 1/2 you can withdraw contributions and any investment earnings without paying a cent of tax on them.
Another advantage to the Roth IRA: there are no required minimum distributions (RMDs). You can keep your Roth account for as long as you want, while a traditional IRA will force you to withdraw money starting at age 70 ½, which can prove unfavorable if you wanted your investments to continue growing.
At a glance, the chart below demonstrates the broad features and the differences between a traditional IRA and Roth IRA. The income and contribution limits set by the IRS are subject to change on a yearly basis.
|Traditional IRA||Roth IRA|
|Income limits||None||Modified AGI must be below certain amount|
|How you contribute||Use pretax dollars. Receive tax deductions for contributions.||Make contribution from after-tax income. No tax deductions.|
|How your money grows||Tax-deferred||Tax-free|
|(Penalty-free) withdrawal qualifications||59 ½ years-old and up||59 ½ years old and up and an account at least five years-old|
|Withdrawal taxes||Income tax||No income taxes|
|Required withdrawals||Minimum withdrawals start at 70½ years old||None|
|Home buyer exception||No penalties for first-time home buyers under age 59½||No penalties for first-time home buyers under age 59½|
You can own both a traditional IRA and Roth IRA, but remember that the contribution limit still applies as a total for all accounts. For example,you might contribute $2,000 to your Roth IRA, and $4,000 to your traditional IRA for the 2019 calendar year.
Additionally, you can own both an IRA and a 401(k), which has a different contribution limit. For 2019 the maximum contribution you can make to a 401(k) is $19,000.
Whether a Roth IRA is best for you depends on whether you'd benefit from a tax break now or later. It requires a little guesswork, namely when will you withdraw the money in the future, and whether or not you think you’ll be in a higher tax bracket at that time.
For example, if you choose to open a Roth IRA in your 20s when you make $35,000, and withdraw when you have a six-figure salary in your 60s, you’ll have effectively saved on income taxes. That’s because you went from a lower income tax bracket to a higher one.
Your home may be your most important investment of all. Make sure it’s protected with homeowners insurance.
Policygenius can help you get coverage that fits your finances.
Policygenius’ editorial content is not written by a certified financial planner or advisor. It’s intended for informational purposes only and should not be considered legal, financial, or investment advice. Consult a professional to learn what financial products are right for you.
This post contains references to products or services from one or more of Policygenius' advertisers or partners. While these codes earn us a small fee at no additional cost to you, they do not influence editorial content and we only refer products we love.
Was this article helpful?
Security you can trust
Yes, we have to include some legalese down here. Read it larger on our legal page. Policygenius Inc. (“Policygenius”) is a licensed independent insurance broker. Policygenius does not underwrite any insurance policy described on this website. The information provided on this site has been developed by Policygenius for general informational and educational purposes. We do our best efforts to ensure that this information is up-to-date and accurate. Any insurance policy premium quotes or ranges displayed are non-binding. The final insurance policy premium for any policy is determined by the underwriting insurance company following application. Savings are estimated by comparing the highest and lowest price for a shopper in a given health class. For example: for a 30-year old non-smoker male in South Carolina with excellent health and a preferred plus health class, comparing quotes for a $500,000, 20-year term life policy, the price difference between the lowest and highest quotes is 60%. For that same shopper in New York, the price difference is 40%. Rates are subject to change and are valid as of 2/17/17.
Copyright Policygenius © 2014-2019