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Published: Nov 11, 2020 10 min read

A Roth IRA is an individual retirement account where the money you deposit is taxed upfront. Since you're funding your account with after-tax money, your investments grow tax-free. You can also withdraw contributions from your Roth IRA at any point, but you may have to pay taxes and penalties on your earnings.

What You Should Know:

  • You can have a Roth IRA account regardless of your age.
  • Roth IRAs are recommended for people who are in a lower tax bracket, or below 25%.
  • You can withdraw your contributions to a Roth IRA penalty-free at any time for any reason but may be penalized for withdrawing earnings before the age of 59 ½.
  • Under the CARES Act, you can withdraw up to $100,000 from your Roth or traditional IRA penalty-free in 2020 if you’re under 59 ½ and have been affected by COVID-19.

While Roth IRAs seem like a great investment for younger people, their tax benefits are a great choice for people of all ages. If you're in a lower tax bracket now and anticipate having higher taxes upon retirement, a Roth IRA could be worth considering.

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Unlike traditional IRAs, a Roth IRA will allow you to pay taxes on funds upfront rather than when you retire. That means high earners may benefit more from a traditional IRA. For one, top earners are generally in a higher tax bracket before they retire.

Additionally, depending on their filing status and income, some people may be restricted from contributing to a Roth IRA altogether.

According to Alicia Munnell, professor of Management Sciences at Boston College’s Carroll School of Management and Director of the Center for Retirement Research, deciding on a Roth IRA really is just a question of people’s perception of relative tax rates in the future and their individual circumstances.

Experts predict Congress will have to increase tax rates in the future because of the country’s growing debt burden. This is better known as an overall tax rate. Your individual tax rate will depend on your filing status, income, and the combination of your effective tax rate (taxes due based on tax statements) and marginal tax rate (tax rate paid on net income). Munnell refers to this as relative tax rates, because they vary from person to person.

“We're going to have higher tax rates in the future than what we have today, so you would be smarter to pay taxes now rather than having to pay higher taxes when you retire,” said Munnell.

Roth IRA vs. Traditional IRA

Roth IRAs have one main advantage over traditional IRAs: since your investments are made with after-tax dollars, once you reach retirement you’ll get every penny of your savings tax-free.

“When you look at your pile, that whole pile is yours,” said Munnell, referring to Roth IRA funds. “When those of us who have traditionally been saving to traditional 401k plans look at our retirement savings, we can say, I know that maybe 80% of that pile is mine, but 20% belongs to the government.”

Here’s a breakdown of their differences:

Traditional IRA vs. Roth IRA
Traditional IRA Roth IRA
Contributions to Traditional IRAs are made with before-tax dollars, meaning that you delay paying taxes until retirement. Contributions to Roth IRAs are made with after-tax dollars, meaning you’ll pay taxes now rather than when you retire.
Investments will grow tax-free.
No adjusted gross income limits to participate. Must meet adjusted gross income limits to participate.
Contributions limited to $6,000, plus an additional $1,000 if you’re age 50 or over.
You can deduct contributions if you qualify. Your contributions aren’t deductible.
Withdrawals of contributions and earnings are subject to federal and most state income taxes. If you’re under age 59 ½ you may have to pay an extra 10% tax for early withdrawals, unless you qualify for an exception. Withdrawals are a bit more flexible. You can withdraw contributions penalty and tax-free at any point. However, if you withdraw investment earnings before the age of 59 ½, you may be subject to tax and penalty charges — unless it’s for a qualifying reason.
You are required to withdraw money by April 1 of the year after you reach age 72. If you’re the owner of the Roth IRA, there’s no age limit to start withdrawing money. However, if you’re a beneficiary of the Roth IRA, you may have to take distributions.
You can contribute to your traditional IRA after age 70 ½ provided you have earned taxable compensation. You can continue contributing funds to your Roth IRA at any age.

Who Can Open a Roth IRA?

To be eligible to open a Roth IRA, you must have earned income. The Internal Revenue Service defines taxable income and wages as money earned from a W-2 job or self-employment such as childcare providers or babysitting.

One of the great things about Roth IRAs is that there’s no age limit to open an account. In other words, if your child did some babysitting throughout the year and earned $500, they can contribute that entire amount to a Roth IRA under their name. However, if the child is younger than 18 (or older, depending on the state) the parent/guardian has to open up the account as a custodian.

Rangely Garcia / Money

You can open a Custodial Roth IRA or Custodial Traditional IRA for a child, and once he or she reaches the age of majority, typically 18 or 21 years-old, all assets and rights will be transitioned to them.
You can open a Roth IRA as long as you earn taxable income and wages, or money earned from a W-2 job or 1099 - if you are self-employed.

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Roth IRA Contribution Limits

The amount you can contribute to your Roth IRA depends on your income level. Let’s say you're a college student and you earned $3,500 as a graduate assistant in 2020. Currently, the Roth IRA contribution limit is $6,000 for 2020 or the total amount of income you earned for that year. Since you earned $3,500 through your graduate assistantship, you can contribute up to $3,500 to your Roth IRA.

The IRS also places income eligibility restrictions for Roth IRAs, so you may not be able to contribute if your income exceeds a certain threshold.

Roth IRA Income Eligibility Restrictions
Filing Status 2020 Income Range
(modified AGI)
Contribution Limit
Single, head of household, or married filing separately (and you didn’t live with your spouse at any time during the year) • Less than $124,000
• At least $124,000, but less than $139,000
• $139,000 or more
• $6,000 ($7,000 if age 50+)
• The amount you can contribute is reduced (or phased out)
• You can’t contribute to a Roth IRA
Married, filing jointly, or qualifying widow(er) • Less than 196,000
• $196,000–$206,000
• $206,000 or more
• $6,000 ($7,000 if age 50+)
• The amount you can contribute is reduced (or phased out)
• You can’t contribute to a Roth IRA
Married, filing separately (and you lived with your spouse at any time during the year) • $0–$10,000
• $10,000 or more
• $6,000 ($7,000 if age 50+)
• You can’t contribute to a Roth IRA

Withdraw Early from your Roth IRA

You can withdraw contributions from your Roth IRA whenever you want, tax and penalty-free. However, taking out investments earnings too early may result in a tax penalty, unless it’s for a qualifying distribution or if you meet certain exceptions. Exceptions include purchasing your first home, qualified education expenses, disability, or having a child, to name a few.

Additionally, distributions from Roth IRAs are more flexible for retirees than those of traditional IRAs. Under Traditional IRAs, individuals must withdraw a required minimum distribution (RMD) by the age of 72 ½. Meanwhile, Roth IRAs have no such requirements — unless you’ve inherited a Roth IRA.

In order to make "qualified distributions" in retirement, you must be at least 59 ½ and at least five years must have passed since you first began contributing.
Opening a Roth IRA

  • You’ll need a few documents to open a Roth IRA, including:
  • A driver’s license or an equivalent form of identification
  • Social security number
  • Employment information
  • Name, address, and social security number of beneficiaries
  • Your bank’s routing number and checking or savings accounts

Depending on your bank or the investment company of your choice, a Roth IRA application can be completed in just under 15 minutes.

Once you open an account, you’ll need to decide how you want to invest the money that goes into your Roth IRA portfolio. You can ask a financial advisor for help, but it’s easy to do it yourself.

Investments can be set up in your Roth IRA by either customizing your portfolio and picking investments, options, stocks, or exchange-traded funds (ETFs); or by purchasing a mix of individual stocks and bonds.

Keep in mind that there are some items that the IRS prohibits you from including in your Roth IRA, these include certain collectibles and life insurance.