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What is a Roth IRA, and How Can it Benefit You?

Unlocking the Power of Roth IRAs: A comprehensive guide to understanding how Roth IRAs work, their pros and cons, eligibility requirements, contribution limits, and how to set up your own account.
June 26, 2023

A Roth IRA is a type of retirement investment account that helps individuals reach their goals of saving enough money for retirement. It is one of many ways to start putting away money towards your retirement fund. The money you put in this account will grow over time. A Roth IRA grows until you reach 59 ½-years-old, at which point, tax-free withdrawals will provide funds for retirement.

How Exactly Does a Roth IRA Work?

There are two types of IRA’s: the traditional IRA and the Roth IRA. The  main difference is that with a traditional IRA, you’ll deduct now and pay taxes later. With a Roth IRA, you’ll pay taxes now and get tax-free withdrawals later.

A Roth IRA allows for tax-free growth and early withdrawals (subject to limitations). The latter means that if you incur a high expense, you can tap into your Roth IRA to get the funds you need. However, there are often penalty fees associated with early Roth IRA withdrawals. Some expenses, such as home purchases and college expenses, might qualify for fee-free withdrawals.

The reason Roth IRA accounts are tax-free is that the money you deposit into your Roth IRA is money you were already taxed on.

In 2020, the US government elected to allow citizens to make early Roth IRA withdrawals without penalty to help those affected by COVID-19. This flexibility is not typically offered in a traditional IRA, with a Roth IRA, access to qualified funds without penalty before age 59 ½ is a significant advantage of choosing a Roth IRA.

Roth IRA Eligibility & Contribution Limits

Roth IRA eligibility is based on income. Make sure you know your tax filing status (individual, married filing jointly, or married filing separately). Your tax filing status impacts your income eligibility bracket and the amount that you can contribute on a yearly basis.

In 2021, single adults must make under $140,000 and married adults must make under $208,000 to qualify.

The Roth IRA has very limited yearly contribution allotments. Qualified individuals can contribute a max of $6,000 in 2021; if you’re age 50 or over, it is $7,000.

The 50+ contribution limit for someone over 50-years-old is called the catch-up contribution. The catch-up contribution allows those closer to retirement to catch up as needed towards retirement goals.

The money you contribute to your Roth IRA must come from earned income (not from assets, such as selling your home, or benefits like social security). Roth IRAs can also not be funded with proceeds from investments, such as capital gains from the stock market or rental property income.

The Pros and Cons of a Roth IRA

The biggest advantages of a Roth IRA are the ability to save money and watch it grow tax-free over time and the flexibility to access emergency funds from your investment account as needed.

One of the disadvantages is that you might owe a penalty fee on those funds if you withdraw them before retirement. Additionally, the contribution limits can be cumbersome.

Is a Roth IRA Ever a Bad Idea?

The Roth IRA is a great tool that can generate significant funds for retirement and meeting the maximum every year is doable. Most importantly, Roth IRAs are low maintenance, meaning you will not need to worry about having to upkeep your account.

The Roth IRA is never a bad idea if you meet the eligibility requirements.

How to Sign Up for a Roth IRA

You can sign up for a Roth IRA through any brokerage. Some examples are:

You can typically set up a Roth IRA completely online from the comfort of your home. Some brokers require a minimum balance to get started, but others do not. Shop around until you find the one that makes the most sense for you.

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